A bleak growth environment being priced in
Valuations clearly look inexpensive today, below 1.1x forward P/BV. On an implied cost of equity basis, the stocks are trading at levels not seen since the global financial crisis. This looks odd given forecast ROEs look in line with long term averages. On our new “what’s priced in” model, the banks appear to be valued as “ex-growth” franchises. As we have argued in the past, with valuations at these levels i.e. close to the trough seen during “non-crisis” periods, a lot of bad outcomes look priced in.
Positive catalysts missing. Higher payout/share buyback could be a silver lining
Inexpensive valuations are rarely enough for rerating though. A much needed positive catalyst for the sector is clearly missing. Many investors have thought rising rates to be one such catalyst. We continue to hold an opposite view on this; even the management NIM outlook is no longer optimistic now. A potential positive however is the yield support and a possibility that the banks might deploy capital through higher dividends or share buy backs to support ROEs (10% payout increase equals 10bps ROE uplift). UOB special dividend announced in Q3-15 was an indication. Peers might follow suit.
Earnings headwinds abound. 10-15% drag on earnings possible A slowing China, stronger US dollar and falling asset prices in a rising rate environment create plenty of revenue headwinds for the banks. A turn in the NPL cycle also looks around the corner with the oil price continuing to be under pressure. The bigger issue however is the low levels of provisions that make earnings very sensitive to rising impairments this time around. For the sector, a rise of 10bps in credit costs implies a 5- 6% drag on EPS. We don’t expect balance sheet stress (or severe liquidity challenges) but a 10-15% earnings drag in the next couple of years looks possible.
If history is any guide a share price recovery could be possible in H216
Our analysis of 19 historical NPL cycles globally suggests that bank share prices typically bottom out 3-4 quarters before NPLs peak. The average duration of this sample of NPL cycles was 6-7 quarters (trough to peak). This would suggest a potentially more constructive outlook for the Singapore bank share prices towards the second half of 2016. Within the sector, we continue to prefer OCBC over the rest and expect its relative outperformance to continue. (Read Report)
Source : UBS Global Research