• Record year in FY18
• Another record year for FY19
• DBS is our pick

FY18 Was a Stellar Year for Banks

4Q18 results for all three banks were down, but this was not a complete surprise considering that global market was weak in the final quarter of 2018. As a result, the three banks reported -7% to -26% QoQ decline in 4Q18 earnings. Nonetheless, full year earnings were at record highs for all three banks, ranging from net profits of S$4,008m (UOB) to S$5,577m (DBS).

Share Prices Were Lackluster Despite Market Rally

Last year, the STI fell 9.8%, while the FTSE ST Financials Index (FSTFN) dropped 8.7%. Even with the recent gains in the market in 2019, the indices have not recovered to the 2018 highs in May 2018. The STI is 12.6% away from the 2018 high. At the 2018 high, the FSTFN was trading at 14.3x forward earnings and price-book of 1.2x. This has now dropped to about 1.0x book.

The lackluster performance so far this year could partly be due to expectations of lower fee income as well as expectations that there is not going to be any further Fed rate hike for the rest of this year. With another record year projected for FY19, albeit at a lower single-digit growth in terms of earnings, it is not unreasonable to expect the index to trade back to the norm or the 10-year average of 1.1x book.

Similarly, with projected record earnings in FY19, it is not unreasonable to expect a re-rating of the banking stocks back to the 10-year average, pending no deterioration in market conditions.

DBS Is Our Pick for the Sector

Currently, the banks are trading at between 1.1 to 1.3x or an average of 1.2x historical book. If we raise the average to 1.3x book, together with a 10% premium for DBS over the other two banks which has been the case in recent years, this will bring estimated fair value estimates to quite similar levels as our projected fair value estimates for DBS and UOB.

Our fair value estimates are S$29.31 for DBS and S$28.30 for UOB. At 25 March 2019 closing prices of S$25.12 and S$24.95, DBS is trading at 1.3x book and UOB is at 1.1x. In addition, dividend yields are 4.8% for both.

Source: OCBC Research - 26 Mar 2019