We retain our BUY call and GGM-based TP of MYR21.00 (11% upside). Public Bank’s 2Q15 results met our and consensus expectations. Notably, 2Q15 operating income rose 10% YoY and 2% QoQ despite challenging macroeconomic conditions as loan growth was sustained, while efforts to grow non-interest income continued to gain traction. Asset quality also improved. Public Bank is our Top Pick for the sector.

2Q15 net profit of MYR1.20bn (+13% YoY, +2% QoQ) was within our and consensus estimates, with 1H15 net profit of MYR2.37bn (+14% YoY) accounting for 49.5-50% of our and consensus net profit forecasts. An interim DPS of 24 sen was declared (2Q14: 23 sen).

Results highlights. In our view, the key positive was the +10% YoY/+2% QoQ growth in 2Q15 operating income, despite the challenging macroeconomic environment. This was achieved on the back of: i) sustained group loan growth of 11.5% YoY while annualised growth of 11% was above the 9-10% target. QoQ growth momentum, however, eased to 2% (1Q15: 3% QoQ) but we think this was still decent given the implementation of the goods and services tax (GST), and ii) robust non-interest income momentum (2Q15: +15% YoY, +3% QoQ), thanks to unit trust and transactional banking fees, as well as treasury operations. Other positives were that 2Q15 overheads remained under control with the cost-income ratio (CIR) at 31.2% (1Q15: 31%; 2Q14: 31.7%) and solid asset quality. Absolute gross impaired loans declined 2% QoQ (-8% YoY) while gross impaired loan ratio and loan loss coverage stood at 0.5% and 129% respectively. 2Q15 net interest margin (NIM), however, slipped by an estimated 7bps YoY (-1bp QoQ) due to funding cost pressures as well as the stronger deposit growth (vis-à-vis loan growth) during the quarter.

Loan and deposit growth. Key loan growth drivers were residential mortgages (+12% YoY) and lending to SMEs (+16% YoY). Meanwhile, total customer deposits rose 12% YoY and 4% QoQ, led by fixed deposits while current account and savings account (CASA) deposits grew 7% YoY (flat QoQ). Hence, loan-to-deposit (LD) and CASA ratios declined QoQ to 87% (1Q15: 88%) and 24% (1Q15: 25%) respectively.

Capital. Estimated fully-loaded group and bank common equity tier-1 (CET-1) ratios were 10.7% and 10.3% as at end-June, up from 10.4% and 10% respectively as at end-Mar 2015.

Forecasts and investment case. No change to our earnings forecasts, GGM-derived TP of MYR21.00 and BUY recommendation.

Briefing highlights

On track to meet 2015 targets. The group remains on track to meet its 2015 targets of: i) ROE of >16% (1H15: 16.5%, annualised), ii) total capital ratio of >13% (1H15: 15.4%), iii) gross impaired loan ratio of <1% (1H15: 0.54%), iv) CIR of <32% (1H15: 31.1%), v) loan growth of 9-10% (1H15: 11%, annualised), and vi) deposit growth of 9-10% (1H15: 13.6%, annualised). Management thinks 2015 GDP could come in at the lower end of the 4.5-5.5% range and hence, there is downside risk to the earlier 8-9% industry loan growth expectations. That said, Public Bank retains its 2015 loan growth target of 9-10%, supported by residential mortgages and small and medium-sized enterprise (SME) lending. Its loan approval pipeline has also been relatively stable, especially from SMEs.

NIM compression could be more severe than expected. NIM guidance, however, was revised to compression of 12bps in 2015 (8-10bps contraction expected earlier), with funding cost still the main source of the NIM pressure. Management still sees banks competing aggressively for retail deposits in order to meet regulatory requirements. Apart from that, industry deposit growth has also slowed and management has seen a general shift from CASA to fixed deposits, where interest rates are more attractive. All these are putting upward pressure on funding cost. Efforts to help cushion the funding cost pressures include: i) asset yield management from products such as used car financing, and ii) focus on CASA growth. Apart from that, ongoing initiatives to grow non-interest income and further cost efficiency can help bolster overall returns, according to management.

No red flags on asset quality. Management has not noticed any red flags with respect to asset quality and has retained the credit cost guidance of <20bps for 2015.

Risks

The risks include: i) slower-than-expected loans growth, ii) weaker-than-expected NIMs, and iii) a deterioration in asset quality.

Forecasts

No change to our earnings forecasts.

Valuation and recommendation

We maintain our BUY recommendation and GGM-derived TP of MYR21.00. Our GGM assumes: i) 8.8% COE, ii) 16% ROE, iii) 4.5% long-term growth, and iv) 2015F BVPS of MYR7.91. Our TP is based on 2015 P/BV of 2.66x, a discount to the 3.2x 10-year average. We believe the discount is fair as the group moves to a period of lower ROEs on more stringent capital requirements.

Amid an uncertain and volatile macroeconomic environment, we believe Public Bank offers investors a safe hideout. We like the group for its good earnings predictability (eg less reliant on markets-related income), sound asset quality and cost efficiency. The resiliency of its 2Q15 results helps reaffirm the abovementioned factors. Capital-wise, the group is now one of the bette domestic capitalised banks post last year’srights issue. Finally, its book value has remained relatively resilient during times of adverse bond yield and forex movements, thus preserving its book value growth and the ability to continue creating shareholder value.

Financial Exhibits

Financial Exhibits

SWOT Analysis

Company Profile

Public Bank is one of Malaysia's largest financial services providers with overseas operations that include Cambodia, Vietnam, Laos and Hong Kong.

Recommendation Chart

Source: RHB Research - 31 Jul 2015