Pakistan Banking Sector: A case of multiple re-rating

Pakistan Banking Sector: A case of multiple re-rating

Policy rate cuts overplayed for banking stocks: Banking sector stocks’ performance has remained subdued during the last twelve months barring the exception of MCB. This quietness in stock performance can be attributed to regulatory changes such as falling interest rates and increasing minimum profit rates. However, we believe discount rate cuts have been overplayed on the basis of one year bottom line decline though banking sector’s profitability growth shall start to rebound from Cy14.

Multiples below historical levels: While the market multiple has been on a steady rise, multiples of banking sector stocks still remain well below their historical levels. Our top picks, UBL, BAHL and BAFL, are trading well below their historical average trailing P/E ratios. Despite an overhaul in BAFL, the stock still trades at a modest trailing Price/book multiple of 0.81x and a trailing Price to earnings multiple of 5.42x. Furthermore, qualitative factors such as brand equity, market positioning and asset quality of our top picks have improved over the years against historical benchmarks.

Multiples adjustment overdue: MCB Bank Limited’s trailing P/E and P/BV multiples have reached 13.5x and 2.73x respectively, while UBL is still trading at a trailing P/E and P/BV multiple of 7.66x and 1.44x. We anticipate UBL’s stock re-rating at higher multiples in coming months, while MCB to re-rate at lower multiples which should bring down the multiple gap currently existing between the two banks. (Refer to chart-3 and chart-4).

Profits to pick up from Cy14: Back to back policy rate cuts resulting in NIM attrition shall likely result in negative bottom line growth for banking sector in Cy13. However, this NIM attrition shall likely end by the end of current calendar year, while net interest income growth shall start to pick up amid strong deposit growth. While investor apprehensions  for  Cy13  profitability  are  understandable, we  anticipate  banking stocks to rally in coming months as investors start to make investment decisions based on Cy14 earnings growth.

Regulatory changes may also benefit banks: Regulatory changes like 1) falling interest rates, 2) increasing profit rates on savings account and 3) profit payment on average deposits rather than minimum deposits has taken its toll on banking sector’s performance. We don’t anticipate any further policy initiative that will hamper profitability growth. Meanwhile, with new government in place, it will be easier for bankers to make their point of view heard in policy and power corridors, which may provide some regulatory relief to the banking industry.

BAHL, BAFL, MEBL and UBL remain our top picks: We remain bullish for our top picks on account of strong dividend yield, improved asset quality, strong brand franchise and likely resurgence of bottom line profitability growth from start of next calendar year. Investors have been weighing Cy13 earnings for now; we anticipate more weightage shall be given to Cy14 earnings in coming months which shall reignite interest in banking stocks.

 

Research contribution : Optimus Capital Management