HNB reported a steep decline in Q1 CY 19 EPS of LKR3.87 (-55.7% yoy; -58.9% qoq) coming largely from a surge in credit costs that absorbed a robust top-line performance. Impairment charges jumped three-fold yoy, and NPL ratio increased by 1.8ppts qoq driven mainly by a weak SME segment. The ongoing tepid economic conditions would lead to increasing credit costs in CY 19e, while also leading to a prolonged recovery of NPLs, in our view.
Sluggish credit growth across the industry remains another concern, and we believe this will continue into H2 CY 19e with political uncertainty adding to the woes. We cut our TP for HNB to LKR 138.00/share (+8.5% TSR) and LKR125.00/share (+7.9% TSR) for HNB NV. Downgrade both classes to Hold.
Asset quality deteriorates further; prolonged recovery. Gross NPL ratio rose to 4.63% in Q1 CY 19 vs. 2.78% in Q4 18. The Bank’s NPL stock increased 67.4% qoq (after a 5.4% qoq drop in Q4 CY 18), which leads us to turn more cautious about the next few quarters. Management indicated that the SME segment drove the deterioration (c30% of loan book; NPL ratio of c10%) underpinned by weak underlying economic conditions. While we expected the asset quality to improve in H2 CY 19, the Easter attacks put a dampener on this, and we now expect additional sectors (retail trade, manufacturing) to experience cash flow stress, which would lead to a delay in NPLs recovery.
High impairments lead the drop in bottom line; trend to continue in CY 19. Reported EPS of LKR3.89 was a steep decline (-55.7% yoy; -58.9% qoq) driven largely by a three-fold increase in impairments. As a result, the group’s TTM cost of risk surged to 175bps vs. 103bps in CY 18. The large pick-up (analogous with the rise in NPLs) came from SMEs. Given the current weak economic environment post the Easter attacks, we increase our credit cost estimate in CY 19e to 108bps vs. 80bps previously.
Tepid loan growth to continue through CY 19e, while NIMs would flatten out. Reflecting the weak private sector credit growth seen across the banking sector (+0.5% yoy) in Q1 CY 19, HNB’s loan book expanded by 0.8% qoq (+13.9% yoy). We expect the slowdown in credit growth to continue from the impact of the Easter attacks on the economy, despite the policy rate cut initiated by the CBSL. Accordingly, we expect loan growth to come in at 6.0% yoy in CY 19e (vs. 16.0% yoy previously). The deposit rate ceiling would be supportive of NIMs expansion initially, but rising NPLs and the indications by the CBSL to reduce lending rates would lead NIMs to flatten out in CY 19e.
Weak momentum and sector headwinds to weigh on valuation. HNB currently trades at 0.49x CY 19e BV, while HNB NV is at 0.47x, and we believe that industry headwinds and general weak market sentiment would cap any upside to the stock in the mid-term. HNB remains well capitalised, so we do not see any overhang from this. But, with the market weakness expected to continue well into H2 CY 19, we believe that the stock will see further pressure in the coming months. Accordingly, we lower our TP for HNB to LKR138.00/share (+2.2% upside; +8.5% TSR) and LKR110.00/share (1.1% upside; +7.9% TSR) for HNB NV. Downgrade to Hold.