The Bell about –UBL: Strong growth to follow slow CY13 – Elixir Securities Limited

Karachi, February 28, 2013 (PPI-OT): United Bank Ltd (UBL) is the third largest bank in Pakistan with a deposit base of PKR700bn. The bank is gearing up its deposit mobilization efforts with the addition of 155 new branches in the last two years, which reflects a 14% expansion in branch network.

According to Elixir Securities Limited management is also making efforts for improved cost controls and development of non- fund based businesses particularly via its branchless banking product, “Omni”.

Improved outlook on asset quality, coupled with balance sheet growth, will likely lead to a 19% growth in earnings in CY14 after a 13% decline in CY13. UBL trades at CY13E PBV of 1.2x. Elixir Securities Limited Dec-13 PT of PKR105 offers an upside of 13% in addition to a dividend yield of 7.6%. BUY Expansion in branch network to help sustain balance sheet growth: UBL has expanded its branch network by 14% by adding 155 branches during the last two years, which helped increase deposit growth to 14% in CY12 from an annual average of 8% during CY09-11. Elixir Securities Limited conservatively expect deposit growth to average 12% going forward, as focus on enhancing CASA shall offset deposit contribution by the new branches.

Improving asset quality to help reduce credit cost: UBL intends to enhance loan portfolio selectively to the corporate sector and SMEs while staying cautious in consumer lending. With 85% of NPLs classified in the loss category and coverage at a decent 78%, NPL growth will likely slow down to 3% going forward from an average of 14% during CY10-12. Steady growth in non-funded income: UBL has the second highest ratio of non-funded income to total revenues. Growth in non-funded income has remained stellar at 14% per annum during the last three years. UBL’s branchless banking product, “Omni”, is gaining popularity through its country-wide network of 8,000 shops now to be complemented by Khushali bank’s recent acquisition.

Valuation: UBL is trading at CY13E PBV of 1.2x and offers CY13 ROE of 16.7%. Elixir Securities Limited has valued UBL using an exit P/BV multiple of 1.3x on Dec-13 book value. Elixir Securities Limited P/BV multiple is based on an equity discount rate of 16.5% (based on a risk free rate of 9.5% and equity risk premium of 7%), sustainable ROE of 19.1% and payout ratio of 55%. Elixir Securities Limited Dec-13 PT of PKR105 offers upside potential of 13% along with a dividend yield of 7.6%. BUY!

UBL Financial Highlights

 CY10ACY11ACY12ACY13ECY14ECY15E
EPS

9.12

12.66

14.71

12.84

15.26

17.72

DPS (PKR)

5.0

7.5

8.5

7.1

8.4

9.7

BV/share

55.9

64.7

74.5

79.2

86.7

95.5

PER (x)

10.2

7.3

6.3

7.2

6.1

5.2

Dividend Yield

5.4%

8.1%

9.1%

7.6%

9.0%

10.4%

PBR (x)

1.7

1.4

1.2

1.2

1.1

1.0

ROA

1.7%

2.1%

2.2%

1.7%

1.8%

1.8%

ROE

17%

21%

21%

17%

18%

19%

NII growth

4.1%

15%

-2.2%

-4.1%

11%

12%

Net Profit growth

21%

39%

16%

-13%

19%

16%

Source: Company Accounts, Elixir Research

Earnings to dip in CY13 but bounce back strongly in CY14

UBL will likely deliver a back loaded 3-year EPS CAGR of 6.4% despite 13% decline in CY13 earnings, driven by a reversal in the interest rate cycle and further supported by balance sheet expansion, lower provisioning charges and an expanding footprint in the non-funded business. The discount rate was cut by a massive 250bps to 9.5% during CY12 which will inevitably lead to margin contraction in CY13. Subsequent drop in lending yields, lower yields on investments, and sticky deposit costs will result in NIMs to drop by 106bps in CY13, after a contraction of 92bps in CY12.

The same will pull down CY13E earnings by 13% YoY. Elixir Securities Limited factors in a 100bps hike in interest rates in mid-2013 based on expected increase in inflation and heightened macroeconomic risks. Elixir Securities Limited believes the same will drive CY14E earnings growth of 19% and push ROE to 18.4% compared to 16.7% in CY13E.

Expansion in branch network to help sustain balance sheet growth

UBL’s deposit growth has remained strong, with deposits growing at a 5-yr CAGR of 12%. With a deposit base of PKR700bn, UBL is now the third largest bank in terms of deposits, after HBL and NBP. Average YoY deposit growth over the past four quarters has been the second highest at 16% after HBL (28%). The bank’s commitment to deposit mobilization is reflected in the addition of 155 new branches during the last two years, with plans to add another 10 in CY13. While the low interest rate environment will compel the bank to focus on raising CASA deposit, Elixir Securities Limited believes the recent branch additions will keep deposit growth at 12% going forward as the new branches begin to contribute to deposit base.

Focus on raising CASA to help contain cost of funds

CASA base has remained in the range of 70-72% in the past three years. Elixir Securities Limited believes lower interest rates will compel the bank to enhance the proportion of low-cost CASA deposits from 72% at present to 74% by the end of CY13. This will somewhat help contain deposit costs amid decline in yields on earning assets in the aftermath of recent monetary easing.

Growing loan book to support yields on earning assets

Ongoing cost consolidation and steady growth in deposit base will provide grounds for UBL to pursue asset expansion particularly commercial loans in domestic and regional markets. Recent monetary easing, and the resulting decline in asset yields amid downward sticky deposit cost, has led to substantial contraction in NIMs. As a result, UBL has started to focus on high yielding assets once again, which is evident from loan growth of 12% in CY12 compared to 12% cumulative contraction in loan book during the last three years. UBL’s loan growth remained the highest in the industry. Elixir Securities Limited has built in an average loan growth assumption of 12% for the next three years, which shall cushion NIM contraction going forward as advances earn a higher rate than investment in government securities. With loan growth in line with deposit growth, ADR will likely remain unchanged at 52% going forward.

Selective lending to keep NPL growth in check

UBL gradually reduced its exposure towards consumer banking from 31% in CY08 to 12% in CY12, due to slow down in NPL accretion and reduced impact of NPL aging as 85% of NPLs are classified in the loss category. NPL coverage ratio also stands comfortable at 78%. This would lower credit cost to 0.8% in CY13 from an average of 1.4% during CY10-12. While UBL has geared up loan book expansion, the bank intends to enhance loan portfolio selectively to the corporate sector and SMEs while it will continue to stay cautious in consumer lending. In addition, better payback capacity of borrowers in a low-rate environment will ensure improvement in recoveries.

Therefore, NPL growth will likely slow down to 3% going forward from an average of 13% over the last three years. Recent additions in NPLs have also been partly driven by the government guaranteed loans to the power sector, which would likely be reversed going forward. As such, Elixir Securities Limited expect s gross infection ratio to gradually improve to 11% by CY15E from 14% at present.

Steady growth in non-fund based income

Non-funded income has delivered a 3-year CAGR of 14% over CY09-12 and of 10% excluding the one-time gain during CY12. UBL’s branchless banking under the name of Omni is gaining popularity through its country-wide network of 8,000 “dukaans” (shops) now to be complemented by Khushali bank’s recent acquisition. Additionally, UBL’s growing investment in mutual funds and foreign securities will add on to the dividend income earned by the bank in future. UBL’s share of non-funded income in total income has been rising and is currently the second highest amongst peers at 31%.

International operations offer risk diversification

UBL has an edge over its peers as it has an extensive global presence. Through 18 international branches, mostly located in the middle-east, the bank employs 24% of its total assets and generates 13% of profit before tax from international operations. Global presence lowers the country specific risk applicable to UBL. It also provides UBL a partial hedge from economic downturns, and slow-down in credit off-take that may hamper the growth of other local banks in Pakistan. While 2008 Middle East crisis raised investor concerns regarding the health of UBL’s international business, UBL did not have to take heavy write downs, indicating a healthy asset quality of international business.

International operation’s contribution
Deposits

28%

Advances

27%

PBT

13%

Total Assets

24%

Net Assets

34%

Source: Company Accounts, Elixir Research

Valuation

UBL is trading at CY13E PBV of 1.2x and offers a dividend yield of 7.6%. Elixir Securities Limited Dec-13 PT of PKR105 reflects an upside potential of 13% from current levels. Elixir Securities Limited has valued UBL using an exit P/BV multiple of 1.3x on Dec-13 book value. Elixir Securities Limited P/BV multiple is based on an equity discount rate of 16.5% (based on a risk free rate of 9.5% and equity risk premium of 7%), sustainable ROE of 19.1% and payout ratio of 55%. Elixir Securities Limited recommends BUY on UBL with an expected total return of 20.6%.

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