January 30, 2014 MORNING BRIEFING Pakistan Banking Sector FABL: Prime candidate for rerating, Buy with a TP of Rs23 + 9221 111-574-111 KSE100 Index: Closing 34,408.74 ↑ (21.88) Ext: 3099 We reinstate our coverage on Faysal Bank Ltd (FABL) with a ‘Buy’ rating. Our Dec-2015 TP of Rs23 offers an upside of 27%. We believe FABL is a prime candidate for rerating given (1) return to double-digit ROE from 2014E, (2) 5-year forward earnings CAGR of 14% vs. historical 5-year CAGR of 11% and (3) improving CASA. Reuters Code: FYBL.KA FABL’s NIMs have witnessed a sharp improvement over the past few years, with FABL now enjoying the highest NIMs in mid-tier banks. Target Price: Rs23 Last year, FABL expressed its intentions to convert its conventional banking operations to Islamic operations over the next two to three years. Bloomberg Code: FABL PA Key risks to our investment case stems from (1) the bank’s poor loan book quality and (2) struggling Cost to Income ratio. Bank to double-digit ROE to drive rerating We reinstate our coverage on Faysal Bank Ltd (FABL) with a ‘Buy’ rating. Our Dec2015 TP of Rs23 offers an upside of 27%. We believe FABL is a prime candidate for rerating given (1) return to double-digit ROE from 2014E (sustainable ROE of 11.5% over 2015-2019F), (2) 5-year (2015-2019F) earnings CAGR of 14% vs. historical 5-year CAGR of 11% and (3) improving CASA. FABL trades at 2015F P/BV of 0.75x vs. peer average of 1.46x, where we believe improving fundamentals of the bank will lead to convergence to peer multiples. FABL ROE vs P/B Market Price: Rs18.24 Market Cap: Rs19bn, US$188mn 1-yr Avg. Daily Volume: 4.0mn shares, Rs63mn, US$0.6mn 1-yr High / Low: Rs19.25 / 11.7 Estimated free float: 365mn shares (35%) FABL performance relative to KSE-100 FABL 175% KSE-100 Index 155% 135% 115% 1.5 6.0% Dec-14 Nov-14 Sep-14 2.0 8.0% Jun-14 2.5 1 yr fw d P/B (RHS) Mar-14 Core ROE 10.0% May-14 12.0% Feb-14 95% Dec-13 KATS Code: FABL Aug-14 Amreen Soorani [email protected] Source: KSE, * based on adjusted prices 1.0 4.0% 0.5 Key statistics - (Rs mn) 2014E Net Markup Income 13,149 13,831 15,400 Source: JS Research Total Income 17,313 18,033 19,821 PIBs and improving CASA lifting NIMs NIMs 3.87% 3.96% 4.02% FABL NIMs have witnessed a sharp improvement over the past few years, with FABL now enjoying the highest NIMs in mid-tier banks. NIMs accretion has been led by (1) increase in income from PIB investments and (2) replacement of fixedterm deposits by zero cost deposits. The bank has increased its investments in PIBs to 50% of its total investments. We believe higher interest earning assets will be broadly replaced by short term government papers going forward given sharp decline in its loan book to deposits (9M2014 ADR at 65%, -12pt in two years). Despite this, FABL still boasts the highest ADR in JS Banking Universe. At the same time, FABL has brought its fixed-term contribution down to 34% (-9pps in two EPS 2.0% 0.0% 2008 2009 2010 2011 2012 2013 2014E 2015F 2015F 2016F Non Markup Expense 12,222 12,171 13,288 EPS growth DPS 1.93 2.71 3.17 9% 40% 17% - - - BVPS 21.69 24.40 27.57 P/BV 0.84 0.75 0.66 0% 0% 0% 10% 12% 13% Dividend Yield Core ROE Source: JS Research JS Research is available on Bloomberg, Thomson Reuters, CapitalIQ and www.jsgcl.com Please refer to the important disclaimer on the last page Page 1 January 30, 2015 MORNING BRIEFING years) while its CASA has increased up by the same magnitude to 66% in 9M2014. We do not foresee an aggressive deposit growth for the bank going forward given post RBS acquisition deposit growth has been 11% vs. industry’s growth of 14%. 3Q2014 Islamic Banking ratios ADR 35% IDR 72% Leverage 3Q2014 NIMs & Deposit Allocation 18 CASA 62% Shariah/Total Investment 19% 100% 5.0% 80% 4.0% 60% 3.0% 40% 2.0% 20% 1.0% Pakistan market statistics (Jan 29, 15) 0% 0.0% KSE-100 Index 34,408.74 Previous KSE-100 Index 34,386.86 BAHL FABL MEBL Total Current Account Mid-tier Avg HMB AKBL SNBL BIPL Source: JS Research 21.88 Change from last closing Other NIMs Source: Company Accounts Islamic operations can potentially unlock value 7,785.61 KSE Market Cap. (Rs. bn) KSE Market Cap. (US$ bn) 77.14 Total Volume (Shares mn) 206.59 Last year, FABL expressed its intentions to convert its conventional banking operations to Islamic operations over the next two to three years. On this front, we pin immense potential for the bank on rising demand for Islamic Banking products in the country. The bank already runs 53 Islamic branches (20%) and would need to convert the remaining 217 branches to be compliant. FABL has shown exceptional performance within its Islamic operations, where despite of limited Shariah investment options it has maintained an IDR above 70% given 50% growth in Shariah deposits. Traded Value (Rs. bn) Operational inefficiencies limiting growth Source: KSE Key risks to our investment case stems from (1) the bank’s poor loan book quality and (2) struggling Cost to Income ratio. FABL is carrying a high level of infection ratio post RBS acquisition, which can potentially limit bank’s return generation. We incorporate a smooth decline in FABL’s infection ratio together with increase in its Coverage ratio. In addition, despite of the recent VSS, the bank holds the highest Staff Cost/ Branch (Rs19mn vs. industry’s average of Rs12mn in 2013) and Cost to Income of 66% (vs. industry’s average of 48%) signaling room for another VSS. 0.06% Change from last closing (%) 14.67 145.35 Traded Value (US$ mn) 22,353.38 KSE-30 Index Change from last closing 36.02 Change from last closing (%) 0.2% KSE Futures Volume (Shares mn) 32.94 3,394.47 KSE Futures Value (Rs. mn) 13.03% KSE Futures Spread KSE valuations 2013A 2014A/E 2015F P/E (x) 11.0 9.3 8.6 P/BV (x) 2.2 2.0 1.9 Div. Yield (%) 4% 5% 5% 10% 18% 8% Earnings growth Source: JS Research Also in Focus Govt approves tariffs for Thar coal-fired power projects The National Electric Power Regulatory Authority (Nepra) has notified upfront tariff of US8.5015cents/unit for Thar coal-based power projects of 330MW on foreign financing, while tariff for similar capacity projects on local financing has been fixed at US9.5643cents/unit. The ROE of 30.65% annually has been allowed for the projects having construction period of 40 months and 34.49% annually for the projects having a construction period of 48 months. JS Global Capital Limited 6th Floor, Faysal House, Shahrah-e-Faisal, Karachi Research: Equity Sales: Tel: +92 (21) 32799005 Tel: +92 (21) 32799513 Fax: +92 (21) 32800163 Fax: +92 (21) 32800166 [email protected] [email protected] This report has been prepared for information purposes by the Research Department of JS Global Capital Ltd. The information and data on which this report is based are obtained from sources which we believe to be reliable but we do not guarantee that it is accurate or complete. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors who should seek further professional advice or rely upon their own judgment and acumen before making any investment. This report should also not be considered as a reflection on the concerned company’s management and its performances or ability, or appreciation or criticism, as to the affairs or operations of such company or institution. Warning: This report may not be reproduced, distributed or published by any person for any purpose whatsoever. Action will be taken for unauthorized reproduction, distribution or publication. Page 2