We retain our SELL call but adjust our TP to MYR11.70 (from MYR12.00, 12% downside) now that the stock is trading ex-rights. Although the rights issue places HL Bank as one of the better-capitalised banks domestically, we think the group may struggle to achieve bottomline growth with pressure on both revenue and cost fronts. We expect a sharper deceleration in ROEs due to the enlarged capital base.

Capital strengthened but outlook still challenging. We are incorporating Hong Leong Bank’s (HL Bank) MYR3bn rights issue into our model, now that the stock has gone ex-rights. We estimate this will strengthen the CET-1 ratios (fully-loaded) for the group and bank to 11.6%/10.9% from 9.1%/8.1% respectively, placing HL Bank as one of the better-capitalised banks domestically. That said, we believe the group may struggle to achieve bottomline growth ahead due to, among others: i) net interest margin (NIM) pressure especially from funding as system liquidity has tightened, ii) normalising overheads growth (adjustment to the depreciation policy in FY15 (Jun) capped the rise in operating cost to just 1% YoY) and credit cost, and iii) weaker contribution from its associate, Bank of Chengdu. Already, 1QFY16 ROE slipped to 11.6%, compared with 14.3% in FY15 and 15.3% in FY14. We see ROEs decelerating further in FY17-18F to 10.2-10.5% with the rights issue.

Forecasts. We raise our FY16-18 net profit forecasts by 2-4% for higher net interest income but our EPS projections have been diluted by 11-15%. We now expect HL Bank to post FY16/FY17/FY18 ROEs of 11.5%/10.5%/10.2%, compared with 12.2%/11.7%/11.2% respectively pre-rights.

Investment case. We adjust our GGM-derived TP to MYR11.70 from MYR12.00 to reflect the stock trading ex-rights. There is no change to our GGM assumptions, which include: i) cost of equity of 10%, ii) ROE of 10.5%, and iii) long-term growth of 4.5%. Our TP is based on a fair 2016F P/BV of 1.09x, which is at a discount to its 10-year average P/BV of 1.9x. This is to reflect the lower ROEs (FY16-18F: 10.2-11.5%) that we project HL Bank to achieve going forward, relative to its average 10-year ROE of 15.4%. As ROE expectations are lowered (consensus estimates: FY17/FY18 ROEs of 12%/11.2%), we expect this to lead to a de-rating of the stock and therefore, retain our SELL recommendation.

Financial Exhibits

Financial Exhibits

SWOT Analysis

Company Profile

Hong Leong Bank Bhd is involved in the provision of conventional and Islamic banking services. The group’s operations span across Malaysia, Singapore, Hong Kong, Vietnam and China, via its strategic shareholding in Bank of Chengdu.

Recommendation Chart

Source: RHB Research - 1 Dec 2015