We maintain our Hold rating for both SEYB and SEYBX, but increase our TP for SEYB to LKR 77.50 (+7.3% TSR) and SEYBX at LKR 40.50 (+9.6% TSR) based on better market momentum. The bank’s weak asset quality (NPLs at 6.49%; +53bps qoq) and capital requirements (rights issue in the pipeline) would weigh on any major pick up in valuations. EPS in Q2 CY 19 was LKR1.71 (-11.4% yoy; A Sec: LKR1.82), with the weakness coming mainly from the soft top line and high impairments. Loan growth, in contrast, grew 2.1% qoq mainly on corporate business, which we believe would gain traction in Q4 CY 19e. SME business continues to see cash flow stress and there has been no reduction in the construction sector NPL. Overall, we do not see a material improvement in the credit quality conditions in H2 CY 19.
Weak earnings driven by soft top line; NIM continues to be under pressure
Net interest income (NII) was down 2.0% qoq (+0.2% yoy) largely due to a contraction in NIMs (-12bps qoq; -36bps yoy) due to: 1) high NPLs (6.49%) which do not generate income, and 2) loan growth coming through high-end corporates with low yields. Given that both factors would continue to prevail throughout CY 19e, we expect the NIM to remain under pressure in H2 CY 19 as well. However, robust FX gains (net FX liability position on balance sheet and lower SWAP costs) drove a strong performance in other operating income (+26.6% yoy) and partially cushioned the blow on the top line.
Loan book expands on corporate lending; CY 19e to come in above industry
While the already reported peers (and the industry, as widely expected) saw contracting credit, SEYB’s loan book grew by 2.1% qoq (+13.7% yoy). This was driven by corporates, but management indicated that credit was focused on short-term requirements. In addition, SEYB highlighted a pick-up in housing loans due to dropping interest rates and cooling prices. Without any further external shocks, we forecast the loan growth of 10.5% yoy for CY 19e.
Asset quality continues to deteriorate; further pick-up in H2 CY 19e
NPL ratio for the bank rose to 6.49% (+0.5pp qoq), with a 11.2% qoq increase in NPL stock. SME segment, and especially the borrowers in the construction sector, created the higher exposure to SEYB. Management indicated that some of the smaller players are yet to receive the payment for government contracts, leading to sustained cash-flow stress. While this would continue through H2 CY 19e, we expect the weak economic conditions to add to stress in sectors such as trading and believe SEYB’s NPLs could reach 7.2% by end-CY19.
We value SEYB at LKR 77.50/share and SEYBX at LKR 40.50; Hold
SEYB currently trades at 0.7x CY19E BV while SEYBX trades at 0.4x, with a ROE of 9.4%. We maintain that a rights issue is on the cards in CY19e and expect SEYB to raise cLKR 5-6bn equity in H2 CY 19. While the share price has picked up with an overall market re-rating, we expect the valuation to reflect, 1) SEYB’s asset quality issues and 2) the pending RI. Following the recent market rally, and including our initial RI assumptions, we set our 12-month TP for SEYB at LKR 77.50 (+3.3% upside; +7.3% TSR) and a TP of LKR 40.50 (+2.0% upside; +9.6% TSR). Maintain Hold.