HBL’s poor reported earnings in 2QCY19 (EPS: PKR0.44; down 81%yoy) mask its solid core business performance. We cut our 2019/20f EPS estimates by 32/9% but see a modest impact on our medium-term projections, with a 17-18% ROE still on the cards through the cycle. Our revised Dec’20 target price is PKR160/sh (vs. PKR165/sh previously) and we retain our Buy stance.
HBL core business remains strong, backed by stable CASA, resilient asset quality, and rebounding fee income. Admin costs remain high for now, but cost normalization is expected from 2H19, as the business transformation project completes. This should lead HBL’s earnings to depict a strong pickup, we see profits doubling in 2020f, followed by a 3yr CAGR of 20%.
The new guidance for winding up of the New York branch is for early 2020f. That said, we believe the associated risks (including the possibility of a modest follow-up fine, if any) are already adequately priced in - HBL trades at a 46% discount to its previous 5yr P/B and also at a 20% discount to closest peer UBL despite similar ROTE projections.
Poor reported earnings mask solid core business performance
HBL posted consolidated NPAT of PKR652mn (EPS: PKR0.44) in 2QCY19, down 81%yoy. Poor reported earnings were largely a function of an fx loss on an open US$ position after the PKR depreciated by 12% during the quarter, and a loss on sale of equity securities. These take attention away from positives such as a 20%yoy growth in net interest income, resilient asset quality (domestic NPLs have reduced), and good fee growth (up 13%yoy) backed by market share in trade financing recovering to 9%.
Target price trimmed to PKR160/sh; Buy stance maintained
Larger-than-expected hits to non-core lines compel us to cut our 2019/20f EPS estimates by 32%/9% to PKR10.36/21.20. This is despite an increase in our 2019/20f average policy rate forecasts to 11.90%/12.25%, from 11.50%/11.25% previously. However, our medium-term EPS projections remain broadly intact and we still continue to see HBL delivering 17-18% ROE through the cycle. As a result, our Dec’20 TP sees a modest revision to PKR160/sh, from PKR165/sh previously. We maintain our Buy stance as valuations are attractive - HBL trades at a 20% discount on P/B to closest peer UBL despite similar ROTE projections. Our new revised target price for HBL also conservatively incorporates a sustainable cash payout of c 35%, down from just under 40% previously. We have built in a PKR15bn ADT-1 instrument (of which PKR8.4bn has already been raised).
Earnings have troughed
We believe HBL is at the bottom of the earnings cycle, with a significant improvement in profits expected from 2H19 onwards. Despite the guidance for loan growth to taper off from c 20%yoy now to the early double-digits, HBL appears on track to deliver 25% NII growth in 2019f. This is largely due to re-pricing, but a stable current account mix in deposits is also an impressive achievement in the higher interest rate environment. Asset quality is resilient with the stock of domestic NPLs reducing in 2QCY19, and no new infection overseas. Despite the tougher economic backdrop, we think HBL is likely to restrict its cost of risk to less than 50bps in 2019f. We see the cost of risk at c 80bps in 2020/21f, but this should not offset the momentum from rising margins and normalizing costs.
Costs normalization from 2H19 onwards
Following the cleanup of the equities portfolio (minor remaining unrealized loss) and the PKR finding a foothold, HBL’s earnings should show less volatility going forward. Management has a plan to close down the open fx position, with more color on this expected in 2H19. The new guidance for windup of the New York branch is for early 2020f, and this is likely to be the single most important checkpoint for the bank. In the interim, HBL is expected to show more normalized costs from 2H19 - the domestic business transformation project is nearly complete; and, although it will now extend to the overseas business, management has guided that the cost will be significantly lower. We project HBL’s cost/income to improve to c 55% by 2023f vs. 75% in 2019f and 64% in 2020f.
Valuations are very attractive
HBL trades at a 2020f P/B of 0.8x and P/E of 5.7x, while offering a dividend yield of nearly 6%. On P/B, HBL is at a 46% discount to its previous 5yr multiple, and at a 20% discount to closest peer UBL despite similar ROE projections for both banks through the cycle. HBL’s revised Dec’20 target price of PKR160/sh offers an ETR of 39%. Our Buy stance is underpinned by a strong core business and valuations that, in our view, are adequately pricing in risks emanating from the New York branch.
Risks: i) General macroeconomic risks in Pakistan as well as the other countries HBL operates in, (ii) another large fine on the New York branch, (iii) continued losses from non-core lines and (iv) continued cost slippages.