Equity Analysis /
Pakistan

United Bank: Valuations open up again; reiterate Buy, trim TP

    Raza Jafri
    Raza Jafri

    Executive Director, Research

    Yusra Beg
    Yusra Beg

    Senior Investment Analyst

    Intermarket Securities
    9 August 2019

    We reduce our 2019-23f EPS estimates for UBL by 4% on average, and trim our Dec’20 target price to PKR170/sh, down from PKR180/sh previously. However, we maintain our Buy stance as valuations have opened up again following the recent correction. UBL has shed 15% this month and now trades at a 2019f P/B of 0.9x and P/E of 7.6x (2020f: 0.8x, 5.4x). 

    Asset quality remains manageable. After new infection of US$75mn in 2018, overseas NPLs have increased by a modest US$23mn in H1 19. Even if this trend extends into H2 19, UBL’s cost of risk should not cross 80-90bps, in our view. This should be more than offset by rising NIMs, and we see profits rising by 30%-40% in 2019/20f followed by a 15% CAGR until 2023f. 

    The bulk of the downward revision in EPS estimates is concentrated in 2019/20f (-10%/-5%) as we incorporate the weaker-than-expected Q2 19 results, a higher cost of risk and a slow pick-up in revenue. However, ROE through the cycle is still projected at 17%-18%, and strengths such as a robust deposit franchise, a diversified fee base, and good cost control remain intact.  

    Q2 CY 19 performance was mixed: UBL reported Q2 CY 19 NPAT of PKR5,133mn (EPS: PKR4.19), up 51% yoy, which reduces to 11% yoy after adjusting for a PKR2bn pension fund charge in Q2 CY 18. Profits were lower than expected due to (i) drag from PIB holdings keeping NII growth in check, (ii) a large impairment charge on the equities portfolio, (iii) disappointing fee (-7% yoy) and (iv) a loss on discontinuing operations (Tanzania). This is balanced by positives such as (i) reducing domestic NPLs, (ii) current accounts crossing 40% of the deposit mix (all-time high) and (iii) impressive cost control (admin expenses up just 4%yoy). Overseas NPLs increased by US$14mn, on top of the US$9mn increase in Q1 CY 19. 

    Target price trimmed to PKR170/sh; reiterate Buy. We reduce our 2019-23f EPS estimates by 4% on average, concentrated in 2019/20f (-10%/-5% from previous estimates). The cuts have primarily been driven by a higher cost of risk, where new international infection continues to come through, albeit at a modest pace. This more than offsets higher margins after we incorporate higher interest rate projections. Our new 2019/20f EPS estimates are PKR16.45 and PKR23.02, and our revised Dec’20 target price is now PKR170/sh (previously PKR180/sh). However, we maintain a Buy as UBL’s stock price has shed 15% this month.  

    Domestic asset quality is strong, but overseas infection continues. UBL continues to make recoveries from its domestic loan book. This may have lent confidence to management to grow consumer loans at a quicker pace (+30% yoy, mostly in autos). However, the overseas NPLs continue to grow, with an addition of US$14mn in Q2 CY 19. We understand this has largely come through from Qatar and, while the Dubai portfolio has stabilised, there are pressure points in Abu Dhabi (the overseas split is 40% Dubai, 31% Abu Dhabi, 14% Bahrain, 8% Qatar). This may lead to new infection going forward, although not to the extent seen in 2018, in our view. We now build in a c90bps pa cost of risk across 2019-22f, up from c80bps previously. A more cautious approaching in building overseas assets may also result in slower headline loan growth – we see overall loans declining by 1% yoy in 2019f before lifting by 8% yoy in 2020f and 11% yoy in 2020f. 

    Earnings normalisation pushed into 2020f. The domestic business remains strong, but may not hit top gear before 2020f. NII growth is still in the single digits vs. 20% yoy for HBL and 28% yoy for MCB, and the drag from legacy PIBs may keep NII growth in check across the balance of the year. This dilutes deposit optimisation efforts, driven by a current account-led improvement in CASA. At the same time, fee income also appears to be growing slower than potential. Slower revenue growth may thus offset the impressive cost control for now, and push earnings normalisation (and a more meaningful ROE pickup) into 2020f. We expect UBL’s ROE to improve from 12.1% in 2019f to 15.7% in 2020f, and then to c17.5% through the cycle.  

    Maintain Buy after the recent correction. Despite the cut in target price to PKR170/sh, we maintain our Buy stance on UBL as valuations have opened up again following this month’s 15% correction in the share price. UBL trades at a 2019f P/B of 0.9x and P/E of 7.6x (2020f: 0.8x, 5.4x). On forward P/B, UBL is at a c35% discount to its previous five-year average, and this can contract as ROE normalises over the medium-term. Our stance is backed by more comfort on capital, where Tier-1/CAR has improved to 13.5%/17.3%. This can sustain a 45%-50% cash payout, in our view. 

    Risks: (i)  High provisions on the GCC book, (ii) slowdown in  fee income, (iii) failure to retain control over costs and, iv) potential slowdown in loan growth and/or a reduction in dividends going forward if CAR constraints come to the fore.