Finishing at $10.03 yesterday, OCBC has gained approximately 3.4% in the month of August. Making it the best performing index constituent of the STI, contributing 21% of the local benchmark’s winnings this month.
 
Macquarie Equities Research (MER) issued a report on OCBC on 18 August, after the local bank went ex-rights. Here are some excerpts from the report.
 
MER adjusted their estimates for the announced rights issue and model for an increase of OCBC’s stake in Bank of Ningbo to 20%.
 
The key takeaways from the media and analyst briefing were (i) OCBC is considering to sell some non-core assets (ii) further earnings dilution cannot be excluded since the fully loaded Basel 3 CET 1 ratio remains below the level of peers (iii) the WHB synergy story remains very much focused on the revenue side.
 
Impact
Disposal of non-core assets possible – Management indicated that OCBC may sell some non-core assets mainly relating to properties in Singapore and Malaysia outside the banking sector. MER sees this as a slight positive but it will be insufficient to address the full capital shortfall (Basel 3) in MER’s view.
 
Further earnings dilution cannot be excluded – OCBC indicated that the fully loaded Basel 3 CET 1 ratio post rights issue and WHB (but before any increase in the stake of Bank of Ningbo) is expected to be around 10.2%. Assuming an increase in the stake of Bank of Ningbo to 20%, MER estimates a Basel 3 capital shortfall of S$ 3.6bn for 2014E (S$ 2.1bn for 2015E). Capital management exercises mainly include the scrip dividend scheme and potential divestments of non core assets. However, another rights issue cannot be excluded.
 
Unchanged strategy on WHB – The strategy on WHB seems to be very much based on revenue synergies, cross-selling and growth. MER is sceptical on revenue synergy based M&A in general and they believe that volume growth could be constrained by OCBC’s pro-forma Basel 3 capital position.
 
Earnings and target price revision
MER adjusted their EPS estimates for the 12.6% dilution from the rights issue. In addition to that, MER models for an increase in OCBC’s stake in Bank of Ningbo (BON) from currently 15% to 20% which will then be accounted at equity. Based on FactSet consensus, BON will achieve around 20% ROE and trades at 0.8x book for 2015E. While MER has little visibility if BON can meet consensus earnings expectations, the increase in income from associates (by assuming 20% stake in BON) reduces MER’s EPS cuts for OCBC to 7.2%, 6.6% and 6.7% for 2015E, 2016E and 2017E respectively.
 
Price catalyst

• 12-month price target: S$8.20 based on a Price to Book methodology.
• Catalyst: earnings dilution, integration of WHB, non core asset disposals.

 
Action and recommendation
MER maintains their Underperform recommendation on OCBC. The S$ 3.4bn rights issue addresses around half of OCBC’s pro-forma capital shortfall in MER’s view. Based on MER’s estimates, OCBC+WHB (pro-forma) trades at 10.7x earnings vs UOB and DBS of 11.2 and 10.2 respectively for 2015E. This does not reflect execution risks and potential further earnings dilution in MER’s view.

Source: Macquarie Research - 27 Aug 2014