Belief is a wonderful thing …
It remains a work in progress, but DBS's management has made positive changes that MER thinks have increased sustainable profitability despite the difficult interest rate environment. While MER thinks that rates and Non-interest Margins (NIM) will remain persistently low for the next two to three years and the structural issue of over-exposure to Hong Kong remains a drag, the bank’s demonstrated ROA improvement has occurred despite an evident de-risking of the balance sheet.

… but it’s also wise to consider the risks
According to MER, among the known unknowns include a dependence on USD wholesale funding, given that the USD book is at 151%, which could be painful in a liquidity crunch. Operating expenditure growth could continue to exceed revenue growth. Asset quality could deteriorate, especially in offshore markets where DBS has grown quickly – China has been the main focus of investor concerns, but India could become the focus of worry this year. Profitability at the Hong Kong subsidiary is likely to remain weak, and further goodwill writedowns at the group level are not unimaginable. Finally, the perennial issue of expensive M&A in Indonesia still stalks in the night.

It’s not quite perfect, yet
As part of the overall de-risking of the business, MER thinks that DBS should emphasise the development of its consumer business. The IT glitches, if they persist, would hurt the brand far more than the associated direct costs, as the comparative funding advantage in Singapore must be retained. MER also believes that the northeast Asian consumer offers greater potential given DBS’s status as the only bank from Singapore to have a significant presence in HK, China, and Taiwan. Finally, MER suggests stopping the ROE- and EPS-dilutive dividend reinvestment programme, and simply pay all of our shareholders cash dividends.

Valuations are still attractive for long-term investors…
MER raised DBS target price by 20% to the stock’s median fair valuation of S$16.61, which is justified by higher sustainable ROE of 11%. In MER's view, the stock could re-rate further in an environment of rising short-term interest rates, but MER does not expect this to happen until 2014 at the earliest. But at 1.1x 2012E P/BV, 4% yield and 11% ROE off an 11% CET1 ratio, investors are not paying much to wait.

… while short-term traders might wait for better timing
DBS’s share price has climbed 20% YTD, outperforming its Singapore bank peers by 7–9ppt and the FSSTI by 10ppt. Nevertheless, a detailed analysis of the company’s various business section and geographical divisions and what MER believes to be the key risks suggests that the stock still offers value to longer-term shareholders. MER said they would become more aggressively bullish on share price dips.

* Excerpt from MER report dated 14 Mar