Earnings revision backed by sustainable growth
Despite 46% share price appreciation since 2006, we believe Singapore bank
stocks remain attractive. Since 2006, we have raised our 2008 estimates by an
average of 21%. Earnings quality also remains strong because of a resilient
domestic economy and a relative benign interest rate. We estimate this will
produce the highest ROE in a decade.
Implementation stage has just begun
The government’s multi-year initiatives announced in 2006 are just starting to be
implemented and could accelerate domestic demand and in turn credit growth, in
our opinion. Loan growth, which recently re-entered double-digit territory after
nine years, is likely to be sustainable into 2008, and we revise up our 2008E
average earnings 6%. We estimate 17% average sector earnings growth in 2007
and 14% in 2008.
Pricing power
While the interest rate has fallen recently, it remains high enough to keep foreign
banks on the defensive and to give pricing power to local banks. We believe the
threat of a pricing war in the medium term is limited unless the rate falls below
2%.
Rising ROE demands a better premium
We estimate the banks should trade at 2.2x book, or a 2008E PE of 16.6x,
undemanding backed as it is by a 2008E ROE of 13.7%, the best in a decade. The
valuation would also be reasonable compared with the 1990s, when sector PE was
27x, P/BV was 2.6x and ROE was around 13%. Our preferred sector pick is DBS
Bank.
Bank share prices have on average appreciated 46% since the beginning of 2006
year to date, and have moved from a mean PE of 12.9x to 13.9x. We think
valuation remains conservative, as underlying profitability (ROE) is improving.
Equally important, we think bank stocks should be viewed differently from a
few years ago when the economic and interest-rate cycle was working against
the banks. In our view, Singapore bank stocks are now not only value stocks but
growth stocks and deserve a premium.
The biggest driver for Singapore bank earnings is the re-emergence of a strong
domestic economy. After nearly eight years of deflation, the city state is back on
the growth path, which we believe is sustainable in the medium term. Record
foreign direct investment, tourist arrivals and job creation are just some of the
factors that should make the economic expansion a secular trend rather than a
mere cyclical upturn.
Loan growth, which after nearly nine years entered double digits, is sustainable
into 2008, in our view, based on the strong economic dynamics. Growth has
been concentrated on corporate loans but we expect growth momentum to
spread to consumer loans in 2008. We revise up our Singapore loan assumption
from 8% to 15% and earnings 6%. We estimate 17% average sector earnings
growth in 2007 (excluding one-offs) and 14% in 2008.
While tapering off, the interest rate remains at a level that is beneficial for local
banks. At the current interest rate of 2.6%, the local banks have maintained a
comfortable lead in funding costs over foreign banks and this has permitted
them to be more aggressive in pursuing market share. We estimate the
advantage will evaporate if the rate falls below 2%. We think this is unlikely, as
the Singapore economy is in strong expansionary mode.
We think the main threat to the banks is a drastic slowdown in the domestic
economy and a steep fall in the interest rate. Both could undermine our growth
assumption. The other is M&A risk. Of the three banks, we believe DBS is at
the greatest risk, given its appetite for big assets and after having paid a
handsome premium for Dao Heng in 2001.
However, we think the risk is overblown as DBS’s ability to overpay is limited
by a much smaller Tier-1 ratio and equally important, it has shown discipline in
the past six years in its approach to various M&A opportunities.
Although we expect all bank stocks to re-rate further as valuations at 1.79x
2008E book and 13.4x earnings are attractive, we think DBS has more potential
upside as it is the cheaper of the three based on valuation and has
underperformed substantially year-to-date. DBS has a franchise that we believe
is broad-based enough to capture growth offered by both the domestic and
regional economies. With the highest forecast ROE, we believe DBS deserves a
premium and we raise our 12-month price target from S$26 to S$29.
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