Equity Analysis /
Pakistan

Bank Alfalah: Comfortable on multiple fronts; reiterate Buy, trim TP

    Yusra Beg
    Yusra Beg

    Senior Investment Analyst

    Raza Jafri
    Raza Jafri

    Executive Director, Research

    Intermarket Securities
    29 August 2019
    • We reduce our 2019-23f EPS estimates by 3% on average following the earnings miss in Q2 CY 19 (EPS: PKR1.84, up 12% yoy). However, we maintain our Buy rating with a revised Dec’20 target price of PKR51/sh, which offers an ETR of 34%. The impact on the target price is muted due to a higher projected cash payout ratio of c50% vs. 40% previously, given BAFL’s improved capital strength.  
    • Importantly, BAFL’s asset quality is holding up, and the bank’s margin-led revenue increase is more than enough to offset higher admin costs. Current accounts crossed 47% of deposits in Q2 CY 19, an all-time high, while the NPL stock reduced sequentially. We see 18% NPAT growth in 2019f followed by a 3-year CAGR of 13%, with mid-cycle ROE estimated in the 16.5%-17.0% range.      
    • Capital strength continues to improve – CAR has lifted by c2ppts this year to 16.7% and there is space for further optimisation (RWA density is still relatively high at 54%). This should enable a sustainable c50% cash payout ratio, in our view, leading to a dividend yield of c10%. This adds gloss to a cheap valuation set, where BAFL trades at a 2019f P/B of 0.9x and P/E of 5.7x (2020f: 0.8x and 4.9x). 

    Q2 CY 19 earnings miss on lower-than-expected NII and cost slippages

    Q2 CY 19 NPAT of PKR3,270mn (EPS: PKR1.84) was up 12% yoy. This was lower than our projected EPS of PKR2.15 due to lower-than-expected net interest income (lagged asset re-pricing, an element of suspended markup on some delayed loan repayments, and changes in reporting standards leading to higher borrowing costs). That said, the earnings miss masks BAFL’s strong core business performance underpinned by (i) a lower NPL stock, (ii) CA crossing 47% of deposits (all-time high), (iii) decent 12% yoy fee growth and (iv) higher CAR. The latter enabled an interim cash dividend of PKR2.0/sh, beating estimates.  

    Asset quality remains intact, amid more cautious loan growth

    Despite relatively high consumer and SME exposure, BAFL has managed to reduce its NPL stock in Q2 CY 19. While we understand that this is partly due to regularisation of a loan that was previously classified subjectively, it appears asset quality is holding up in general. As a result, we lower our 2019f cost of risk estimate for BAFL to c30bps from 60bps previously. However, we broadly maintain our 2020f cost of risk estimate at c90bps and medium-term estimates at close to 70bps. We expect loan growth to be in the single-digits in 2019/20f, which should help to contain incremental asset quality pressures.

    Improved deposit mix despite a higher interest rate setting

    Deposit growth is a decent 11% yoy (+9% yoy normalised for Afghanistan operations) and, more encouragingly, the deposit mix has improved despite the higher interest rate environment. Current deposits stand at more than 47% of the mix, an all-time high, while  c20% of savings deposits are Islamic and thereby not subject to a rate floor. This, coupled with pending asset re-pricing, should ensure continued strong NII pick-up going forward (+41% yoy in H1 CY 19). We expect BAFL’s NIMs to expand by c130bps to 5.1% in 2019f (and by another 20bps in 2020f).

    Admin costs are rising, but cost/income ratio is under control 

    Core fee income grew by 12% yoy in Q2 CY 19, with impetus from increasing trade commissions, cards and alternate delivery channels. This is in line with BAFL’s renewed focus on digital banking. However, this (as well as new branches – 50 targeted this year) is also adding to costs, where admin expenses are up 22% yoy in Q2 CY 19. Even after adjusting for deposit insurance costs, this is a quick pace. That said, the high revenue growth should restrict the cost/income to 53% over the medium-term vs. a previous 5-year average of 63%.  

    Better capital buffer unlocks a higher cash payout

    BAFL announced an interim dividend of PKR2.0/sh alongside the H1 19 results, higher than our projected PKR1.5/sh payout. This follows improved capital strength where CET-1 and CAR stand at 13.5%/16.7% vs. 12.1%/14.9% in Dec’18. Given that BAFL’s RWA density has space to reduce from 54% at present (RWA/Assets for ABL and HBL is less than 40%), the capital strength appears adequate. A higher payout should allow BAFL to report mid-cycle ROE of 16.5%-17.0%, in our view.  

    Risks: (i) Greater-than-expected asset quality deterioration, and (ii) cost slippages.