Inter Market Perspective Intermarket Securities is the Local Research Partner of Exotix Capital To find our Research on Bloomberg, please type - IMKP <GO> www.jamapunji.pk ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 14 December 26, 2018 • We initiate coverage on Meezan Bank Ltd (MEBL) - the largest Islamic bank in Pakistan - with a Buy stance and a Dec’19 target price of PKR107/sh. Competition will rise going forward, but due to its head start and strong brand, MEBL will remain the benchmark Islamic bank by some distance. MEBL has risen by 40% in 2018 but we see room for further gains. Our target price offers a 1 year ETR of 29%. • Rising interest rates in Pakistan will demonstrate the strength of MEBL's franchise. Absence of a rate floor on savings deposits and improved asset pricing will lift margins sharply, leading to c. 60%yoy profit growth in 2019f and a medium-term CAGR of 15% thereafter. Importantly, the swift income increase should be enough to resolve weaknesses such as limited CAR buffer and a high cost/income ratio. • MEBL trades at a 2019f P/B of 1.9x and P/E of 7.3x. MEBL is cheap on earnings but the P/B is significantly above the sector's multiples. Premium valuations are justified given projected ROE of 28%+ in 2019f, an all-time high. The median ROE in our coverage next year is 13.8%. The investment case for MEBL is uncomplicated; it is the best bank to play higher domestic interest rates. Our liking is also supported by a favorable regulatory environment for Islamic banking in Pakistan. Business model primed to benefit from rising interest rates Absence of a rate floor on savings deposits (c 38% of the mix) together with a sticky depositor base enables MEBL to enjoy low-cost funding. The current gap is significant - in Nov’18, MEBL paid 3.0% on its basic savings product vs. 6.5% paid by a conventional bank. A historical lack of high-yielding investment products can also change with the government looking to issue big-ticket sukuks to clear circular debt. We see MEBL’s margins rising by a swift 104bps to 4.6% in 2019f, higher than the 53bps median increase for other covered banks. This leads us to project c. 60%yoy earnings growth for MEBL in 2019f, and a 15% CAGR across CY19-22f. Profit growth will be aided by more normalized administrative cost increases, with branch additions likely to gradually decelerate given that the network has already doubled since 2012 to 610 branches at present. We expect MEBL’s cost/income to drop from 56% in 2018f to less than 50% over the medium term. Balance sheet quality to improve MEBL has historically relied on aggressive deposit and loan growth to drive profitability. In the last 5 years, deposit and loan growth have averaged 24%pa and 36%pa, respectively. This has been a successful strategy as the bank was able to maintain strong asset quality. However, it stressed CAR where MEBL had to raise capital in 2017 and 2018 (6% rights followed by a PKR7bn ADT-1 issuance). With profitability to be driven by margin expansion over the medium-term, MEBL can now afford to grow its balance sheet at a more moderate pace, in our view. While management has indicated plans to focus on balance sheet growth with the aim of becoming a PKR1tn deposit bank in the next few years, a high base means incremental growth will likely be slower than in the last 5 years. Accordingly, we build in deposit and loan CAGRs at c 15% over the medium-term. This should end capital raising and enable at least a sustainable 35% cash payout (alongside bonus issuances). MEBL will also have space to improve its deposit mix while further de-risking the loan book, by being more selective on its deposit gathering and lending activities. Premium valuations are warranted ROE should rise from 21% in 2018f to 28%+ in 2019f, an all-time high. This should be driven by a 40bps improvement in ROA to 1.4%, thereby reducing reliance on leverage. We think it is difficult for ROE to sustain near 30% but it should still average at c. 25% across the medium-term, much higher than ROE generation for our other covered banks (MCB is next best with 20% ROE projected in 2022f). Such high return generation warrants premium valuations in our view. We value MEBL at a target P/B multiple of 2.3x on 2019f. This is at a 35%+ premium to MEBL’s average P/B multiple of 1.65x over the last 5 years, but is matched by significantly higher ROE generation (2014-18f: 19%). We also view this year’s private placement by MEBL’s sponsor to foreign institutional investors as a long-term positive, with the increased free float likely to aid further price discovery going forward. Risks: (i) Inability to maintain the current sizeable funding cost advantage, (ii) sharp jump in credit costs given high loan growth in prior years, (iii) possibility of further capital raising if profitability falls short of estimates and (iv) continuation of a high cost/income ratio. An unparalleled franchise Meezan Bank Ltd Initiation of coverage Meezan Bank Limited Price (PKR/sh) 86.06 TP (PKR/sh) 107.00 Stance Buy Upside 24.3% Fwd D/Y 4.6% Total Return 29.0% Bloomberg / Reuters MEBL PA / MEBL.KA Mkt Cap (US$mn) 724.3 52wk Hi-Low (PKR/sh) 99.6/59.05 6m Avg. D. Vol ('000 shrs) 474 6m Avg. Td Val (US$mn) 0.31 MEBL – Valuation Snapshot CY16A CY17A CY18F CY19F CY20F EPS (PkR) 5.29 4.81 7.44 11.82 14.03 EPS Growth 27% -9% 55% 59% 19% PER (x) 16.28 17.91 11.57 7.28 6.13 P/B (x) 3.11 2.68 2.32 1.87 1.53 ROE (avg) 19.2% 15.4% 21.4% 28.5% 27.3% ROA (avg) 1.0% 0.8% 1.0% 1.4% 1.5% DY (%) 3.0% 3.1% 3.5% 4.6% 5.8% Payout Ratio 49% 55% 40% 34% 36% Source: IMS Research MEBL vs KSE100 Index -20% 0% 20% 40% 60% 80% Dec-17 Feb-18 Mar-18 May-18 Jun-18 Aug-18 Sep-18 Nov-18 Dec-18 KSE100 Index MEBL Source: IMS Research Research Entity Number – REP-085 Yusra Beg [email protected]Raza Jafri, CFA [email protected]+92-21-111-467-000
Transcript
Inter Market Perspective
Intermarket Securities is the Local Research Partner of Exotix Capital To find our Research on Bloomberg, please type - IMKP <GO> www.jamapunji.pk
ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 14
December 26, 2018
• We initiate coverage on Meezan Bank Ltd (MEBL) - the largest Islamic bank in Pakistan - with a Buy stance and a Dec’19 target price of PKR107/sh. Competition will rise going forward, but due to its head start and strong brand, MEBL will remain the benchmark Islamic bank by some distance. MEBL has risen by 40% in 2018 but we see room for further gains. Our target price offers a 1 year ETR of 29%.
• Rising interest rates in Pakistan will demonstrate the strength of MEBL's franchise. Absence of a rate floor on savings deposits and improved asset pricing will lift margins sharply, leading to c. 60%yoy profit growth in 2019f and a medium-term CAGR of 15% thereafter. Importantly, the swift income increase should be enough to resolve weaknesses such as limited CAR buffer and a high cost/income ratio.
• MEBL trades at a 2019f P/B of 1.9x and P/E of 7.3x. MEBL is cheap on earnings but the P/B is significantly above the sector's multiples. Premium valuations are justified given projected ROE of 28%+ in 2019f, an all-time high. The median ROE in our coverage next year is 13.8%. The investment case for MEBL is uncomplicated; it is the best bank to play higher domestic interest rates. Our liking is also supported by a favorable regulatory environment for Islamic banking in Pakistan.
Business model primed to benefit from rising interest rates Absence of a rate floor on savings deposits (c 38% of the mix) together with a sticky depositor base enables MEBL to enjoy low-cost funding. The current gap is significant - in Nov’18, MEBL paid 3.0% on its basic savings product vs. 6.5% paid by a conventional bank. A historical lack of high-yielding investment products can also change with the government looking to issue big-ticket sukuks to clear circular debt. We see MEBL’s margins rising by a swift 104bps to 4.6% in 2019f, higher than the 53bps median increase for other covered banks. This leads us to project c. 60%yoy earnings growth for MEBL in 2019f, and a 15% CAGR across CY19-22f. Profit growth will be aided by more normalized administrative cost increases, with branch additions likely to gradually decelerate given that the network has already doubled since 2012 to 610 branches at present. We expect MEBL’s cost/income to drop from 56% in 2018f to less than 50% over the medium term. Balance sheet quality to improve MEBL has historically relied on aggressive deposit and loan growth to drive profitability. In the last 5 years, deposit and loan growth have averaged 24%pa and 36%pa, respectively. This has been a successful strategy as the bank was able to maintain strong asset quality. However, it stressed CAR where MEBL had to raise capital in 2017 and 2018 (6% rights followed by a PKR7bn ADT-1 issuance). With profitability to be driven by margin expansion over the medium-term, MEBL can now afford to grow its balance sheet at a more moderate pace, in our view. While management has indicated plans to focus on balance sheet growth with the aim of becoming a PKR1tn deposit bank in the next few years, a high base means incremental growth will likely be slower than in the last 5 years. Accordingly, we build in deposit and loan CAGRs at c 15% over the medium-term. This should end capital raising and enable at least a sustainable 35% cash payout (alongside bonus issuances). MEBL will also have space to improve its deposit mix while further de-risking the loan book, by being more selective on its deposit gathering and lending activities. Premium valuations are warranted ROE should rise from 21% in 2018f to 28%+ in 2019f, an all-time high. This should be driven by a 40bps improvement in ROA to 1.4%, thereby reducing reliance on leverage. We think it is difficult for ROE to sustain near 30% but it should still average at c. 25% across the medium-term, much higher than ROE generation for our other covered banks (MCB is next best with 20% ROE projected in 2022f). Such high return generation warrants premium valuations in our view. We value MEBL at a target P/B multiple of 2.3x on 2019f. This is at a 35%+ premium to MEBL’s average P/B multiple of 1.65x over the last 5 years, but is matched by significantly higher ROE generation (2014-18f: 19%). We also view this year’s private placement by MEBL’s sponsor to foreign institutional investors as a long-term positive, with the increased free float likely to aid further price discovery going forward. Risks: (i) Inability to maintain the current sizeable funding cost advantage, (ii) sharp jump in credit costs given high loan growth in prior years, (iii) possibility of further capital raising if profitability falls short of estimates and (iv) continuation of a high cost/income ratio.
An unparalleled franchise
Meezan Bank Ltd
Initiation of coverage
Meezan Bank Limited Price (PKR/sh) 86.06 TP (PKR/sh) 107.00 Stance Buy Upside 24.3% Fwd D/Y 4.6% Total Return 29.0% Bloomberg / Reuters MEBL PA / MEBL.KA Mkt Cap (US$mn) 724.3 52wk Hi-Low (PKR/sh) 99.6/59.05 6m Avg. D. Vol ('000 shrs) 474 6m Avg. Td Val (US$mn) 0.31
Investment Thesis MEBL is the largest Islamic bank in Pakistan with a c. 35% share in Islamic banking assets and close to a 4.5% share in overall industry assets. Competition in Islamic banking is rising e.g. MCB has set up a separate Islamic banking subsidiary, but we believe MEBL is now too far ahead of peers - not just in terms of size but also in its brand value - to be seriously threatened regarding its status as the preeminent Islamic bank in Pakistan. MEBL will be a major beneficiary of rising interest rates in Pakistan given it (i) only has domestic operations, (ii) does not face a rate floor on savings deposits, in contrast to conventional banks, and (iii) is likely to realize improved yields on its investments. We see MEBL’s margins at 4.6% in 2019f, up 104bps (vs. a 53bps median increase for other covered banks). Asset quality is excellent with the NPL ratio and coverage standing at 1.5% and 132%, respectively, at Sep’18. After negligible provisions over the last few years, cost of risk will likely rise over the medium-term but should stay close to a manageable 50bps in our view. We think MEBL can further de-risk its loan book by being even more selective when extending loans going forward. We have a positive outlook on capital adequacy and cost efficiency, two weak areas for MEBL. Our projected profit trajectory will fill out CAR, negate the need for further capital raising, and allow at least a 35% cash payout ratio. MEBL has also timed its branch expansion well (network has doubled since 2012), with branches added in the last few years now hitting profitability. A more moderate pace to branch additions, together with swift income growth, should bring the cost/income ratio to less than 50% by 2022f vs. 56% in 2018f. MEBL’s earnings are projected to grow by c. 60% in 2019f, followed by a 3 year CAGR of 15% thereafter. This implies ROE of 28%+ in 2019f an all-time high. ROE for MEBL should average c. 25% over the medium-term, at a time when ROEs for the Big-5 banks will expand gradually to 18-20% levels. Premium valuations for MEBL are thus not only well merited, in our view, and thus have room to expand.
Shareholding Pattern – CY17
Associated Co's, 88.8%
Others, 4.0%
Local Individuals,
3.3%M. Funds,
2.0%
Insurance Co's, 1.2% Directors ,
0.8%
Source: Company Report *Sponsor Noor Financial has sold 10.9% CYTD
Company ProfileOwned by Kuwait’s Noor Financial Investment Co, Meezan Bank Ltd (MEBL) is the largest Islamic bank in Pakistan, with assets of almost US$6.1bn and over 610 branches in Pakistan. The Islamic Development Bank (IDB) has a 9.3% stake in the bank. MEBL also has a 65% stake in Al Meezan Investment Management Limited, which is the largest private sector asset management company in Pakistan with AUMs of US$654mn. MEBL was initially set up as an investment bank in 1997, before receiving the first license to commence commercial Islamic banking in 2002. Since then, the bank has become synonymous with Islamic banking in Pakistan, with a c. 35% market share in the space (and a c. 4.5% share in the overall banking industry). In doing so, it has not only captured the large Islamic banking market (98% of Pakistan’s population is Muslim) but also successfully positioned itself among the major lender to the corporate and consumer segments. MEBL is noted for its strong brand, stable management team and superior asset quality.
Meezan Bank Limited - Timeline
-
20
40
60
80
100
120
Mar
-02
Sep-
02
Apr-0
3
Oct-0
3
Apr-0
4
Oct-0
4
Apr-0
5
Oct-0
5
Apr-0
6
Oct-0
6
Apr-0
7
Oct-0
7
Apr-0
8
Oct-0
8
Apr-0
9
Nov-0
9
May
-10
Nov-1
0
May
-11
Nov-1
1
May
-12
Nov-1
2
May
-13
Nov-1
3
May
-14
Nov-1
4
May
-15
Nov-1
5
Jun-
16
Dec-1
6
Jun-
17
Dec-1
7
Jun-
18
Dec-1
8
PKR/Sh
MEBL
2002: Converts into a commercial Islamic bank
2002: Acquires Pakistan operations of Société Générale
2003: Al Meezan Investment Management becomes a subsidiary
2007: Branch network size reaches 100
2010: Stands among Top 3 auto finance providers
2011: Shifts into new Head Office
2014: Acquires HSBC Pakistan
2017: Branch network crosses 600
1997: Commenced operations as Al Meezan Investment Bank
2018: Sponsor trimsstake
Source: IMS Research
3 | P a g e
Perspective
Business model primed to benefit from rising interest rates Absence of a rate floor on savings deposits (c 38% of the mix) together with a sticky depositor base enables MEBL to enjoy low-cost funding. The current gap is significant - in Nov’18, MEBL paid 3.0% on its basic savings product vs. 6.5% paid by a conventional bank. A historical lack of high-yielding investment products can also change with the government looking to issue big-ticket sukuks to clear circular debt. We see MEBL’s margins rising by a swift 104bps to 4.6% in 2019f, higher than the 53bps median increase for other covered banks. This leads us to project c. 60%yoy earnings growth for MEBL in 2019f, and a 15% CAGR across CY19-22f. Profit growth will be aided by more normalized administrative cost increases, with branch additions likely to gradually decelerate given that the network has already doubled since 2012 to 610 branches at present. We expect MEBL’s cost/income to drop from 56% in 2018f to less than 50% over the medium term. A unique deposit franchise The Islamic banking business model as well as a very strong brand has led to a unique deposit franchise for MEBL, which helps generate low cost funding. Since 2008, conventional commercial banks in Pakistan face a rate floor on savings deposits (more than 40% of the industry’s deposit mix). At present, conventional banks cannot pay less than the Discount Rate minus 2.5% on their savings products. This means that a conventional bank paid 6.5% on its savings product in Nov’18, when the DR stood at 9.0%. Islamic banks face no such rate floor, since the profit : loss sharing model entails that rates cannot be promised in advance. In Nov’18, MEBL paid just 3.0% on its comparable savings product.
While MEBL’s management has indicated it will likely have to increase deposit rates going forward (its savings deposit rate has increased to 4% in Dec’18), a large gap relative to the rate offered by conventional banks is likely to persist, in our view. This affords significant funding cost advantages, especially in a rising interest rate scenario. Across 2018, the rate on MEBL’s savings deposits has increased by a modest 160bps compared to a 425bps increase for conventional banks. We thus see MEBL’s cost of funds rising by a moderate 192bps in 2019f vs. an average increase of 340bps in the Discount Rate.
Strong brand enables a sticky deposit base Other than the business model, low funding costs for MEBL are also a function of the nature of its deposit base. The bank’s CASA is a decent 75%, but this is only at par with the overall banking industry. The key difference lies in the source of these deposits; in MEBL’s case, deposits by individuals contribute a sizeable c 70% of total deposits. For conventional banks, as well as competing full Islamic banks, the proportion of individual depositors in the mix is much lower (54% on average for the rest of our covered banks). For MCB, a conventional bank hailed for its strong deposit franchise as well, individuals comprise 61% of its deposits.
Savings rate behavior for MEBL vs. conventional banks in 2018
0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%
Dec-
16Ja
n-17
Feb-
17M
ar-1
7Ap
r-17
May
-17
Jun-
17Ju
l-17
Aug-
17Se
p-17
Oct-1
7No
v-17
Dec-
17Ja
n-18
Feb-
18M
ar-1
8Ap
r-18
May
-18
Jun-
18Ju
l-18
Aug-
18Se
p-18
Oct-1
8No
v-18
Dec-
18
MEBL Conventional Banks
Source: IMS Research
MEBL’s deposit franchise consistently leads to a low cost funding base
MEBL’s deposit base is loyal and less rate sensitive in our view
4 | P a g e
Perspective This high proportion of individual deposits for MEBL leads to a stable funding base that does not appear to be very rate sensitive, in contrast to corporate deposits. We venture that this enables it to consistently pay a lower rate on its savings deposits compared to other banks, both conventional and Islamic. In doing so, MEBL appears to be fully benefiting from its positioning as the premier Islamic bank in Pakistan. Investments set to reprice quickly In addition to a slow increase in cost of funds relative to conventional banks, MEBL will also benefit from asset pricing. While MEBL’s loan book is expected to re-price similar to conventional banks (with a 3-6 months lag), its investments are re-pricing quickly. Of the PKR125bn of investments on Sep’18 (15% of assets), we estimate that a government sukuk of c PKR40bn has already been rolled over. Given that this sukuk was earlier yielding an estimated 5.5% in CY17 but has now been placed at north of 11%, there will be an immediate increase in the yield on investments. Another PKR28bn government sukuk yielding a fixed 5.6% will mature in 2019 and is likely to be rolled over at much higher yields. Together with repricing loans, we see MEBL’s yield on earning assets rising by a swift 300bps in 2019f. Islamic instruments getting more traction Historically, some of the advantage emanating from low funding costs for MEBL has been eroded by lack of viable investments. Since Islamic banks cannot invest in T-bills or PIBs that offer a fixed rate of return, they have to rely on either advances, government sukuks or short-term placements with scheduled banks (Bai Muajjal) to constitute the bulk of their assets. This may be why MEBL has operated at relatively high ADR levels over the last few years (average c 60% vs. 54% for the overall industry), and also why it settles on a lower yield on assets.
% of individual deposits for MEBL vs. peers
18%26%
33% 34% 38% 39% 40%
50% 54%61% 62% 63%
69%
0%
10%
20%
30%
40%
50%
60%
70%
80%
BOK
BOP
FABL
NBP
HMB
AKBL AB
L
HBL
BAFL
MCB UB
L
BAHL
MEB
L
Source: Company Accounts
Cost of funds for MEBL in CY18f vs. other banks in our coverage
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
MEBL HBL MCB UBL BAFL ABL
Source: Company Accounts, IMS Research
Yield on earning assets will lift quickly
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
CY13
A
CY14
A
CY15
A
CY16
A
CY17
A
CY18
F
CY19
F
CY20
F
CY21
F
CY22
F
Source: IMS Research
Repricing investments will protect the benefits from a low cost funding base.
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Perspective
This is now changing with the government increasingly looking to tap the liquidity available with Islamic banks via sukuks. This is a win-win situation since Islamic banks will be able to place their liquidity at rates better than what they are receiving now, while the government will be able to generate financing at lower rates compared to PIBs. This view is further strengthened by expected issuance of fresh sukuks by the Government of Pakistan for settling the outstanding circular debt balance. As per news reports, sukuks amounting to PKR300bn (in tranches) may be issued by the GoP. MEBL is keen to invest in these and expects to receive a rate close to the T-bill rate (currently 10.55%).
Margin lift to drive profitability in 2019f We estimate that MEBL’s margins reduced from 4.4% in 2015 to less than 3.4% in 2017, inline with a lower interest rate environment. As interest rates have increased this year, we expect margins to clock in at 3.6% in 2018f. However, the lift to margins will be more prominent in 2019f, as the full effect of asset re-pricing is felt. We estimate that MEBL’s margins will increase by 104bps to 4.6% in 2019f, much higher than the median increase of 53bps for the other banks in our coverage (all conventional banks). As a result, MEBL’s profits are expected to grow by a robust c. 60% yoy in 2019f to PKR13.8bn (EPS: PKR11.82). Even if interest rates start to come down over the medium-term, we expect investment yields to be upward sticky while a better CASA mix (75% now vs. less than 70% in 2015) will also help. Profit growth CAGR beyond 2019f may decelerate to the 15% mark – inline with projected balance sheet growth – but this is still a healthy growth rate, in our view, especially as it will come on top of a much larger profit base. We flag that there is room for positive surprises on non-interest income over the medium term – particularly on fee and capital gains - but for now we remain conservative in our projections.
Higher operating income will reduce cost/income MEBL has grown its branch network at an aggressive 10 year CAGR of 20%, with branches almost doubling from 310 in CY12 to 610 at end-Sep’18. This has allowed the bank to achieve leadership position within the Islamic space, but it has impacted efficiency where the cost/income ratio has averaged a high 60% over the last 5 years. While management has indicated it will continue to focus on increasing the brick-and-mortar network (2018f expected to close at 675 branches), the swift expected increase in operating income should help drive cost/income to below 50% in our view. There also appears to be some cost control in business-as-usual activities. Already in 9MCY18, the growth in admin expenses has decelerated to 12% yoy vs. a CAGR of 19%+ across 2012-17.
Margins to drive growth
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
-20%
0%
20%
40%
60%
80%
CY13
A
CY14
A
CY15
A
CY16
A
CY17
A
CY18
F
CY19
F
CY20
F
CY21
F
CY22
F
NPAT (Growth % yoy) - Lhs Net Margin
Source: IMS Research
Profitability will show strong growth in 2019f
Emergent cost control is visible
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Perspective Balance sheet quality to improve MEBL has historically relied on aggressive deposit and loan growth to drive profitability. In the last 5 years, deposit and loan growth have averaged 24%pa and 36%pa, respectively. This has been a successful strategy as the bank was able to maintain strong asset quality. However, it stressed CAR where MEBL had to raise capital in 2017 and 2018 (6% rights followed by a PKR7bn ADT-1 issuance). With profitability to be driven by margin expansion over the medium-term, MEBL can now afford to grow its balance sheet at a more moderate pace, in our view. While management has indicated plans to focus on balance sheet growth with the aim of becoming a PKR1tn deposit bank in the next few years, a high base means incremental growth will likely be slower than in the last 5 years. Accordingly, we build in deposit and loan CAGRs at c 15% over the medium-term. This should end capital raising and enable at least a sustainable 35% cash payout (alongside bonus issuances). MEBL will also have space to improve its deposit mix while further de-risking the loan book, by being more selective on its deposit gathering and lending activities. Market leader in Islamic banking MEBL was the first bank to receive a commercial Islamic banking license in 2002. With its first-mover advantage, the bank has developed a very strong brand and can be considered as synonymous with Islamic banking in Pakistan. In terms of size, MEBL is the 8th largest bank in Pakistan, with a c. 35% share in Islamic banking assets (4.3% share in overall banking sector assets). MEBL has grown its deposits at an impressive 10 year CAGR of 29% (vs. 13% for the other banks under our coverage), and has doubled its branch network from 310 branches in 2012 to 610 branches at present. Strong deposit generation, coupled with a lack of high-yielding investments, has led to focus on extending loans where the bank’s ADR currently stands at 62% vs. 54% for the overall industry.
Balance sheet growth can now be more selective Given that MEBL now has a large balance sheet, incremental growth may depict a natural slowdown. This does not signal lack of intent by management – their target is for deposits to reach PKR1tn in the next few years vs. c PKR700bn at present – but is a reflection of a higher base. Coming from a previous 5 year deposit and loan CAGRs of 24% and 36%, respectively, we expect annual growth rates for both deposits and loans to settle near 15% over the medium-term. This is still better than loan growth in the early double-digits for the rest of the banks in our coverage. MEBL can afford to withstand this slowdown given the strong push from margins.
Some deceleration in balance sheet growth is not a bad thing, in our view. It will allow MEBL to focus more on its deposit mix while also de-risking its loan book further. At the same time, slower asset growth – particularly on loans – should help to further shore up the capital base. This should lead to more stable operations, dispelling concerns on capital where MEBL issued a 6% rights in 2017 followed by a PKR7bn ADT-1 issuance in 2018.
MEBL’s market share in overall industry assets
1.32% 1.52%1.93%
2.22% 2.45%2.82%
3.14%3.61% 3.79%
4.19% 4.29% 4.34%
0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%4.0%4.5%5.0%
CY07
CY08
CY09
CY10
CY11
CY12
CY13
CY14
CY15
CY16
CY17
2QCY
18Source: Company Reports, SBP
A large base means balance sheet growth will now likely decelerate
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Perspective Loan mix has a high proportion of consumer financing MEBL is a pioneer of consumer financing in Pakistan’s Islamic banking industry, currently contributing 40% to the overall Islamic consumer portfolio. Within auto financing, we understand that it is one of the top 3 lenders across the industry, conventional or Islamic. MEBL’s loan mix thus stands at a contrast to the industry; consumer loans have a 13% share in MEBL’s mix compared to less than 5% for the banking sector. For the latter, share of consumer financing in the mix also used to be at 15% back in 2006/07, but continuous de-risking over the last decade has led to a sharp drop in this ratio. Not for MEBL, however, which has continued to focus on consumer financing, in particular auto loans (autos and mortgage financing have an 80:20 mix for MEBL). Management also indicated its intention to focus on the SME and commercial segment, although we suspect that this may not happen immediately given the much tougher macroeconomic backdrop for 2018-19 relative to 2016-17.
Asset quality has been strong but de-risking would be welcome MEBL is known for its very strong asset quality with an NPL ratio of 1.5% (vs. 8.4% for the sector) and provisioning coverage of 132% (87% for the sector). This is despite the aggressive loan growth in the last 5 years as well as the clear tilt towards consumer financing. Although auto financing is secured and is arguably less risky compared to other consumer products, aggressive loan growth in prior years risks a sharp increase in NPLs over 2019-20f. Corporate sector loans could also come under pressure, in our view, given that the macroeconomic environment stands much altered. In this regard, we think it is a good thing that balance sheet growth (especially loan growth) would likely decelerate. Given that the push from the margins increase is so strong, we believe MEBL can afford to decelerate its loan growth without comprising profitability and returns.
Cost of risk to rise but should be manageable A decent part of the loan book (31% in CY17) is extended to public sector entities such as PASCO and TCP. About 17% of the loan book is extended to the power sector, also likely to be government guaranteed for the most part. These are likely relatively low yielding loans but the government-guaranteed nature serves to reduce the risk profile of the overall loan book. MEBL has not been immune to asset quality issues in the past – post the 2008/09 financial crisis, the bank’s NPL ratio shot up to 8.8%. Cost of risk also jumped to as high as 3.5% in 2009 and 2.8% in 2010. Back then however, MEBL did not have any exposure to public sector entities. The loan mix is significantly different now and should serve to limit credit costs to manageable levels, in our view, compared to the blowout a decade ago. Accordingly, we project MEBL’s cost of risk at c 50bps over the next 2-3 years.
MEBL’s loan mix
72%
13%
15%
CY17
Corporate Consumer Commercial
S C A
Banking industry’s loan mix
73%
4%
23%
CY17
Corporate Consumer Commercial
Source: Company Accounts, IMS Research
More than 30% of the loan book is backed by government guarantees, unlike negligible exposure in the past. This can help limit cost of risk in a tougher macroeconomic backdrop.
8 | P a g e
Perspective Room to focus on the deposit mix MEBL has improved its CASA to 75%, from less than 70% in 2015 and 65% in 2011. This improvement has largely been driven by current deposits – while the proportion of savings deposits in the mix has remained in the 37%-40% range, the proportion of current deposits has lifted from 25% to 35%. Given that interest rates have risen sharply in 2018, efforts to further lift CASA in the near-term may not make much headway. That said, if MEBL’s balance sheet growth slows, it would have the opportunity to focus more on the mix. Management wishes to increase the proportion of current deposits by 1%pa. However, we conservatively keep the proportion of current deposits lower than savings deposits in our medium-term projections.
Capital to no longer be a problem A likely corollary of higher expected profit generation and more moderate balance sheet growth would be the boost to MEBL’s capital base. Due to the rapid balance sheet growth in prior years (together with a consistent cash payout), CAR came down to below 11% in 2015. This led to a (i) PKR7bn subordinated sukuk issuance in 2016, (ii) a 6% rights issue in 2017 and (iii) a PKR7bn ADT-1 instrument issuance in 2018. Had interest rates not risen sharply – and by consequence margins also remained range bound – we think MEBL may have had to raise further capital, or risk slowing down asset growth and/or cutting dividends. Now however, due to the sharp increase in profit trajectory, it is difficult to see capital being a problem, at least over the medium-term. We see MEBL sustaining at least a 35% cash payout ratio going forward (together with bonus issuances), with CAR expected to stay above 14% going forward (vs. the 12.5% minimum requirement).
Proportion of public sector share in loans has increased
0%
5%
10%
15%
20%
25%
30%
35%
CY10
CY11
CY12
CY13
CY14
CY15
CY16
CY17
Source: Company Accounts
We think the capital raising phase is over
9 | P a g e
Perspective
Premium valuations are warranted ROE should rise from 21% in 2018f to 28%+ in 2019f, an all-time high. This should be driven by a 40bps improvement in ROA to 1.4%, thereby reducing reliance on leverage. We think it is difficult for ROE to sustain near 30% but it should still average at c. 25% across the medium-term, much higher than ROE generation for our other covered banks (MCB is next best with 20% ROE projected in 2022f). Such high return generation warrants premium valuations in our view. We value MEBL at a target P/B multiple of 2.3x on 2019f. This is at a 35%+ premium to MEBL’s average P/B multiple of 1.65x over the last 5 years, but is matched by significantly higher ROE generation (2014-18f: 19%). We also view this year’s private placement by MEBL’s sponsor to foreign institutional investors as a long-term positive, with the increased free float likely to aid further price discovery going forward.
ROE set to hit an all-time high Even after accounting for one-offs, ROEs for Pakistani banks have declined over the last few years, due to margin contraction as headline interest rates went down to record lows in 2017. MEBL also saw its ROE reduce from 23% in 2012 to 15% in 2017. With interest rates rising again, Pakistani banks will again see higher ROEs from 2019f. For most banks, this uptick will be gradual but MEBL will see an immediate large increase. This is due to its greater margin sensitivity to rising interest rates, strong asset quality and decelerating admin cost increases. We see MEBL posting ROE of 28.5% in 2019f, an all-time high. The next highest in our coverage will be BAFL with 17.5% ROE. Tellingly, MEBL’s previous high ROE of 25.1% was achieved in 2011, which saw the highest interest rates in at least the last 15 years. This further supports our thesis of a strong ROE jump in 2019f where we expect the Discount Rate to average 11.0% vs. c 7.5% in 2018f.
ROA-led increase in ROE Rapid balance sheet growth over the last few years increased MEBL’s leverage from 13.7x in 2011 to 19.8x in 2017. Although this helped to partially offset the reduction in ROA from 1.8% to 0.8% in the same time frame, continuation of such high leverage levels would likely have necessitated further capital raising. This is set to change where an increase in core income drivers, margins in particular, will take ROE from 21.4% in 2018f to an average of 25.0% in the medium term. ROA, not leverage, will provide the key push to ROE. We see ROE rising by c 50bps to 1.5% over the medium-term. At the same time, leverage levels are likely to converge towards a more sustainable 15x, in our view. We flag that MEBL’s returns can clock in above our expectations in case non-markup income surprises, where we have been conservative in our projections for fee income and capital gains (see table on the next page).
ROE to rise sharply in 2019f…
16.1
%
25.1
%
23.1
%
22.3
%
21.4
%
18.1
%
19.2
%
15.4
%
21.4
%
28.5
%
27.3
%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
CY10
A
CY11
A
CY12
A
CY13
A
CY14
A
CY15
A
CY16
A
CY17
A
CY18
F
CY19
F
CY20
F
Source: Company Accounts, IMS Research
…which will dwarf ROEs of other banks in our coverage
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
MEBL BAFL ABL UBL MCB HBLCY19F CY20F
Source: Company Accounts, IMS Research
MEBL’s previous high ROE (25%) was recorded in 2011, tellingly coinciding with high interest rates.
High return generation warrants premium valuations MEBL trades at a 2019f P/B of 1.9x and P/E of 7.3x, vs. a median of 1.0x and 7.4x for the rest of our coverage banks. On P/B basis, MEBL is not just trading at a premium to other banks in Pakistan but also to its own history (its previous 5 year average P/B multiple is 1.65x). We think MEBL’s premium valuations are not only warranted, but merit further rerating as well. MEBL can sustain premium valuations over the medium-to-longer term due to:
• Unparalleled ROE generation: MEBL’s ROE in 2019f will represent an all-time high, with the uptick to be greater than for our other covered banks. With the bank having a very strong asset quality track record, and with cost efficiencies coming in, we do not see MEBL’s ROE coming below 25% in the next 3 years. MEBL’s strong earnings growth – we expect 59%/19%yoy growth in 2019/20f respectively, should also enable it to stand out.
• Improved stock liquidity: MEBL’s sponsor Noor Financial has reduced its stake from 49.1% to 38.2%, via several separate private placements to foreign funds this year (it may sell up to another 4.6% as per disclosures). This may lead to short-term share supply concerns but we understand most of the buyers have been long-only funds. Even if some supply does occur, we think the increase in free float (from 11% last year to more than 20% now) is a long-term positive for further price discovery – daily turnover in MEBL averaged US$0.08mn across 2012-17 but has improved to US$0.28mn in 2018. This makes MEBL investable for a greater number of investors – both domestic and foreign.
• Increasing size of Islamic AUMs: Shariah-compliant funds (equity+fixed income) managed by the local asset management industry now have a 35% share (PKR204bn) in total AUMs (total PKR586bn). MEBL’s own subsidiary Al Meezan Investment Management (of which MEBL owns 65%) is the largest private sector asset management company by AUMs (PKR90.9bn i.e. US$654mn) in Pakistan. Domestic Islamic funds have limited options to invest in financials given conventional commercial banks are not Shariah compliant. There are just two listed Islamic banks in Pakistan – MEBL and Bank Islami Pakistan Ltd (BIPL) – compared to 18 listed conventional commercial banks. As the size of Islamic AUMs grows, there will be a natural demand pool for MEBL’s stock.
MEBL’s free float has increased from 11% last year to more than 20% now
11 | P a g e
Perspective Valuation methodology We value MEBL on a modified Gordon Growth Methodology [(ROE-g)/(CoE –g)] based on mid-cycle ROE and 2022f book value which we discount back, and also include the value of interim dividends. We use a risk-free rate of 11%, equity risk premium of 6%, beta of 1 and a sustainable growth rate of 9%. Our Dec’19 target price of PKR107/sh implies a fair forward P/B of 2.3x. A valuation sensitivity to the risk-free rate is as follow:
MEBL is arguably uncatchable now The strong profit generation for Islamic banks, particularly in higher interest rate environments, is not going unnoticed. Given an Islamic banking license in 2002, MEBL was arguably take lightly by the large conventional banks that still operate via Islamic window operations (except for MCB) with varying degrees of success. This is now changing with Faysal Bank (FABL) looking to convert into an Islamic bank and MCB setting up a dedicated Islamic banking subsidiary. Despite rising competition in the Islamic banking space, we think MEBL is now too far ahead to be seriously challenged. This is due to:
• MEBL’s head start: MEBL commenced operations in 1997 as an investment bank, subsequently converting into a full-fledged Islamic bank in 2002. Since then, MEBL has managed to increase its market share in Islamic banking to c 35%. While we do not think MEBL will increase its market share from here – it will likely become more selective on balance sheet growth – it is difficult to see any other Islamic bank (or window) reaching close to MEBL in terms of size alone.
• Strong brand value: MEBL has built up exceptional brand value and has come to be synonymous with Islamic banking in Pakistan. This is demonstrated by its market share dwarfing that of other dedicated Islamic such as Dubai Islamic Bank Pakistan (9% share) or Bank Islami (8% share). On the deposits side, MEBL’s brand value leads to more sticky deposits (69% of MEBL’s deposits are from Individuals vs. 55% for Dubai Islamic and 29% for Bank Islami). This leads to a strong funding cost advantage for MEBL. Even if new Islamic banks are set up, they will take time to build their own brand and franchise.
Meezan Bank Dubai Islamic Bank Islami Al Baraka MCB Islamic BAFL Islamic Sponsor Noor Financial DIB, UAE JS/Dubai Bank Al Baraka, Bahrain MCB Bank Dhabi Group Status Islamic bank Islamic bank Islamic bank Islamic bank Islamic bank Islamic window Commenced operations 2002 2006 2006 2007 2015 N.A Listed Yes No Yes No No No Assets (PKRbn)** 847 223 207 123 84 141 Islamic market share* 34% 9% 8% 5% 3% 6% Branches (#)** 610 200 330 188 166 152 9MCY18 NPAT (PKRmn) 6,416 1,853 99 -278 -780 2,177
Comments Benchmark Islamic Strong improvement Has recently acquired Awaiting Awaiting breakeven Largest Islamic bank in Pakistan in performance KASB Bank breakeven window
Source: IMS Research, Company Reports * Market share by assets, **Sep’18
Valuation sensitivity to Risk free rate
119
107
98
90
80
100
120
140
9% 10% 10% 11% 11% 12% 12% 13% 13% 14%
Dec'1
9 TP
Pric
e PK
R
Risk Free RateSource: Company Reports
12 | P a g e
Perspective Risks • A key advantage for MEBL is a low cost funding base. If MEBL pays too little on its
deposits compared to other banks, it may risk flight of deposits to competition. That said, MEBL benefits from a loyal depositor base which mitigates this risk.
• The benefit of low funding costs for Islamic banks has historically been eroded by lack of viable investments. We think the government will look to tap sukuks to raise funds going forward, by offering a better return than before. However, if only limited government sukuks are issued and/or attractive yields are not offered, then it is possible that our earnings projections are missed.
• MEBL has maintained a very strong asset quality track record. That said, given the much tougher macroeconomic backdrop together with MEBL’s loan growth CAGR of 36% over the last 5 years, it is possible that asset quality deteriorates more than anticipated. In this case, cost of risk could be greater than our projections.
• We have assumed that admin costs will grow at a 13% CAGR over the medium-term, relatively high compared to the other banks in our coverage but much lower than the previous 5 year CAGR of 19%. If costs grow faster than anticipated, it could lead to our earnings estimates for MEBL will be missed.
• Based on our profitability projections, it appears unlikely that MEBL will need to issue further capital. However, given that CAR buffer is relatively limited, profitability misses could again lead to capital issuances and/or a cut in cash dividends.
(PkRmn) CY16A CY17A CY18F CY19F CY20F Profit Earned 31,430 36,095 47,057 80,340 90,506 Return on Deposits 12,872 15,271 20,756 41,351 45,749 Net Spread Earned 18,558 20,824 26,301 38,988 44,756 Total Provisions (185) 1,320 494 2,709 3,488 Post Prov Net Spread 18,373 22,145 26,795 41,697 48,245 Fee Income 3,942 6,030 6,573 7,263 8,171 Total Other Income 6,865 8,806 8,699 9,383 11,135 Total Other Expenses 16,257 17,414 19,953 23,704 26,899 Profit from Associate 1,166 (963) (24) 602 813 NPBT 10,517 9,933 14,530 22,561 26,316 NPAT 6,182 5,619 8,698 13,818 16,405
(PkRmn) CY16A CY17A CY18F CY19F CY20F Investments 134,797 123,161 132,181 155,798 180,147 Financings 311,530 419,929 485,959 551,971 629,247 Total Assets 663,268 785,967 916,754 1,047,208 1,181,359 Deposits 564,000 673,180 777,534 890,277 1,014,915 Total Liabilities 628,495 747,558 873,792 993,256 1,115,096 Net Assets 34,773 38,410 42,962 53,952 66,263 Tier I Equity 31,092 36,585 42,196 52,507 64,236 Total Tier II Equity 3,681 1,824 765 1,445 2,027 Total SHEQ 34,773 38,410 42,962 53,952 66,263 Total SHEQ and Liabilities 663,268 785,967 916,754 1,047,208 1,181,359
Source: IMS Research
MEBL – PER Band CY19F
Jan-
08
Dec-
08
Dec-
09
Dec-
10
Dec-
11
Dec-
12
Dec-
13
Dec-
14
Dec-
15
Dec-
16
Dec-
17
Dec-
18
(x)MEBL PER (x) Band 10.0
8.0
6.0
4.0
Source: IMS Research
MEBL – PBV Band CY19F Ja
n-08
Dec-
08
Dec-
09
Dec-
10
Dec-
11
Dec-
12
Dec-
13
Dec-
14
Dec-
15
Dec-
16
Dec-
17
Dec-
18
(x)MEBL PBV (x) Band 3.0
2.3
1.5
0.8
Source: IMS Research
14 | P a g e
Perspective
We, Yusra Beg & Raza Jafri, CFA, certify that the views expressed in the report reflect our personal views about the subject securities. We also certify that no part of our compensation was, is, or will be, directly or indirectly, related to the specific recommendations made in this report. We further certify that we do not have any beneficial holding of the specific securities that we have recommendations on in this report. Ratings Guide* Upside Buy More than 15% Neutral Between 0% - 15% Sell Below 0%
*Based on 12 month horizon unless stated otherwise in the report. Upside is the percentage difference between the Target Price and Market Price.
Valuation Methodology: We use multiple valuation methodologies in arriving at a Target Price including, but not limited to, Discounted Cash Flow (DCF), Dividend Discount Model (DDM) and relative multiples based valuations.
Risks: Please refer to page 12. Disclaimer: Intermarket Securities Limited has produced this report for private circulation only. The information, opinions and estimates herein are not direct at, or intended for distribution to or use by, any person or entity in any jurisdiction where doing so would be contrary to law or regulation or which would subject Intermarket Securities Limited to any additional registration or licensing requirement within such jurisdiction. The information and statistical data herein have been obtained from sources we believe to be reliable where such information has not been independently verified and we make no representation or warranty as to its accuracy, completeness and correctness. This report makes use of forward looking statements that are based on assumptions made and information currently available to us and those are subject to certain risks and uncertainties that could cause the actual results to differ materially. No part of the compensation of the author(s) of this report is related to the specific recommendations or views contained in this report.
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