Macquarie Equities Research (MER) believes the rally in Singapore bank stocks is looking tired and would look to pare down holdings at current levels.

MER believes that the recently released solid top line numbers of 1Q13 may represent a short-term top for profitability, as business activity may cool off and margins remain under pressure in Singapore in upcoming quarters. The stocks are not overly expensive but they are trading at levels that MER perceives to be slightly above fair value. This implies limited upside risk in light of MER’s overtly bearish house strategy call on Singapore.

Macquarie Equities Research says “Enough is enough”
In a report released on 20 May, MER’s substantiated their views on the Singapore banks with the following points:

Momentum to slow in 2H13. In MER’s view, 1Q13 was an extremely solid quarter for DBS, and a good quarter for UOB. MER was less impressed with OCBC’s results given the weakening pre-provisioning operating profit. In any case, MER’s believe that upcoming quarters may look weaker for all, given slowing business activity and (MER assumes) lack of major investment banking deals vs 1Q13. MER thus expects a repetition of the pattern of 2012, which had a strong early start with earnings momentum slowing in 2Q-4Q13.

Valuations: Not as attractive as they were. The stocks have rallied 15% year-to-date, ahead of the 8% rise in the STI and the fourth best bank-sector performance by country in Asia. Taken as a whole, the sector is trading at 1.4x its 2013 estimated price-to-book valuation. This is not only the sector’s historical mean, but more importantly in MER’s view this level represents close to fair value – especially given the lack of operational catalysts to the upside. Of the three banks, DBS and UOB are trading at close to MER’s estimate of fair value, while OCBC is most overvalued following the stock’s outperformance year-to-date.

Risks. The banks’ balance sheets are still very strong as shown by their high common-equity tier 1 ratios. This has attracted buying from investors seeking yield and/or a safe haven. While MER does not think this trend will persist, it informs MER’s sense that the downside for the Singapore bank stocks is likely to be limited. Operationally, any of the banks could beat MER’s net income forecasts by posting near-zero provisioning, although MER does not think this – coupled with weak pre-provision operating profit growth – would justify a continued re-rating of valuations.

MER’s outlook for the banks
MER is Neutral on the Singapore banks from a country strategy view, but are switching to a more cautious set of downgraded recommendations. MER is downgrading DBS and UOB to Neutral from the previous Outperform on both. OCBC has also been downgraded to Underperform from Neutral.

MER has no Outperform ratings over the banks. But for investors who wish to maintain exposure to the sector, MER’s top pick is UOB, given the relative simplicity of a bank-centric ASEAN-focussed organic business strategy. The strong operational momentum at DBS would have made the stock a natural choice as top pick, but the ambiguities surrounding the Danamon acquisition keep this one off the “sleep-at-night” list – MER does not know how this may pan out and whether management will accept a non-controlling minority stake. Of the three big banks, MER thinks that OCBC would make the best choice as a funding short.

Source: Macquarie Research - 22 May 2013