Karachi, December 10, 2021 (PPI-OT): HMB: Structural improvements outweigh possible bond book overhang
As mentioned in our note last week, banking stocks will face some short-term overhang on their book values due to mark to market losses on their bond books following the recent 250-300bps hike in market yields. In case of HMB we believe that the structural improvements at the bank outweigh this drag and reiterate our Target Price of Rs80.
Following a 22% return in last 12 months (vs. 3% return for the sector and the market), we strongly believe that the story does not end here for HMB’s price performance as consistent improvement in fundamentals has taken its CY21E Tier I ROE to 21%, nonetheless P/B and P/E remains unjustified at 0.63x and 3.1x, respectively.
Improvement in core income going unnoticed
The banking sector has lagged in the past twelve months gaining broadly in line with the market (3%) over various investor concerns such as tighter regulatory requirements. However, one of the exceptions from the sector has been Habib Metropolitan Bank (HMB) that has given a return of 22% during the same period. We strongly believe that the story does not end here for HMB’s price performance as the bank’s consistent efforts of strengthening deposit mix and improvement in asset quality has still not been completely priced in as yet. Comparing prevailing multiples of banking stocks, the market has been assigning a P/B of 0.5x to 0.75x to most banks, regardless of their respective reported and potential ROEs. HMB hence remains as one of our top picks from the banking sector.
Swift replacement of fixed deposits by zero-cost deposits
Deposit mobilization focus in the right area has continued to favour the bank’s deposit mix as current account deposits have witnessed a 3-year CAGR of 25%. This has not only led to current account share accretion to 34%, but has also decreased the bank’s infamous fixed deposits share to 33% this year; which has previously remained in the vicinity of 41-45% for more than a decade (till CY19). With consecutive outperformance in zero-cost deposit growth in the last 2-3 years, the bank’s cost of funds is reaping benefits with a controlled increase in the same as compared to peers. Improvement in cost of deposits has led HMB to report a 21% 3-year CAGR in Net Interest Income (NII), which comes out to be one of the best performances in core income growth among peers.
ROE support from other areas as well
In addition, ongoing increase in trade volumes of the country has continued to support HMB’s trade income as it ranks as one of the leaders in trade activity amongst peers. The trade income contributes ~10% to total revenue as compared to average 3%-5% for peers. To recall, the bank’s annual trade income have almost doubled in the last three years.
On the asset quality front, which has been a key concern for many prospective investors, HMB has improved its Coverage ratio up to 100% through Specific (94% Coverage) and General Provisions. While HMB’s carries a concentration risk with 42% of loans to the Textile sector, the bank would also be a key beneficiary of any revival in the Textile sector post TERF disbursements. To note, the bank has ~Rs9bn of NPLs under the Textile sector, with ~100% Coverage ratio.
Current multiples do not justify the attainments
The improvement in core income, alongside robust growth in non-core income has increased the bank’s CY21E Tier I ROE to 21%. Assuming no change in deposit mix from here onward and a standard 10% YoY growth on its Fee Income, the bank’s sustainable Tier I ROE still computes to 23%. This includes 100bps increase in Policy Rate from here onward, ~12% annual deposit growth and provisioning expenses of Rs2bn-Rs2.5bn/annum.
We believe the prevailing stock price does not reflect the bank’s consistent improvement in its recurring ROE as it trades at unjustified P/B and P/E of 0.63x and 3.1x, respectively. We highlight the bank’s return generation is similar to banks that trade close to its book value, reflecting a deep discount of ~35%. We therefore expect HMB to outperformance peers with a Target Price of Rs80, on a justified P/B of 1.18x.
The attractive capital upside is in addition to DY of 12%, based on existing payout ratio of ~40%. We highlight the strong CET-I ratio that the bank maintains at 13.9%, one of the highest among peers. We hence do not rule out that the bank has the muscles to gradually return to its previous payout ratio (~55% during CY11-17), which has dropped to ~40% since CY18 gradual buildup of the bank’s CET I ratio post CY18. In an earlier note as we had highlighted concerns on the banking sector’s bond portfolios as at CY21-end given the recent 250-300bps hike, HMB would likely face an overhang on its BV for the short term. Nonetheless, long term prospects of the bank remain optimistic.