Following a pull back in US stocks last Friday (18 Sept), Singapore stocks started yesterday on a weak note. OCBC fell 0.8% at the open, but managed to pare all losses within the first hour of trading and then extended its advance to end the day positive.
 
Macquarie Equities Research (MER) issued a report on OCBC on 18 September with an “Outperform” rating on the local bank. Read on for more excerpts from the report.
 
After the recent share price decline, MER upgrades their rating on OCBC to Outperform – new target price S$10.00.
 
Impact
Asset quality, cost efficiency and dividend payouts as MER’s main investment criteria – OCBC gets points for asset quality (though normalisation of asset quality and provisions will be a headwind) and cost efficiency in Singapore (IT investments largely completed, Wing Hang Bank (WHB) integration is a downside risk). However, dividend payouts are a relative weakness due to the scrip dividend to improve capital ratios (currently 11.2% Common Equity Tier 1 (CET1) ratio).
 
Investment case – On a mid-term view, OCBC is well positioned to benefit from the Asia Wealth Management theme and it is ahead of the curve with investing into its Singapore IT & Digital Banking platform. OCBC is making progress to build up capital and MER thinks it can neutralize the scrip dividend by end 2017. On a 3-5 year view MER believes that a reduction of its 87% stake in Great Eastern is a possibility, which would be a key positive.
 
Asset quality trends – OCBC has the lowest Non Performing Loans (NPL) ratio (0.7%) among the three Singapore banks and the highest NPL coverage (156%). Normalisation of loan loss provisions will however be a key earnings headwind because the current Loan Loss Provision (LLP) ratio (0.15%) is substantially below normalised levels (>0.3%). MER is guarded on OCBC’s Indonesia exposure (7% of total loans), the opaque ‘rest of the world’ and ‘other Asia’ exposure (11% of total loans) and its commodity finance exposure (9% of total loans).
 
Risks to MER’s investment case – Operating trends will be muted and consensus expectations are too optimistic MER thinks. MER remains sceptical on the value realization from the WHB acquisition and they continue to view the 87% stake in GE as a valuation negative (conglomerate valuation discount, P&L volatility and a negative for regulatory capital).
 
Earnings and target price revision
MER cuts their EPS estimates for 2015E-2017E by 5-10%. The main reason for MER’s cuts is a lower revenue growth assumption. MER is 10-15% below market earnings expectations for 2016E-2017E. Due to MER’s EPS cuts, they reduce their target price to S$10.00 from S$10.50 previously.
 
Price catalyst

• 12-month price target: S$10.00 based on a Price to Book methodology.
• Catalyst: impact from mark-to-market losses, asset quality trends, dividends

 
Action and recommendation

• MER has an Outperform rating on OCBC – target price S$10.00.
• MER is a buyer of OCBC based on their belief in (i) OCBC’s strong position to benefit from the Asia Wealth Management theme, (ii) mid-term benefits from investments into product capabilities and investments into Singapore IT and Digital Banking and (iii) possibility to reduce the stake in Great Eastern on a 3- 5 year view.

 Source: Macquarie Research - 22 Sep 2015