Karachi, May 30, 2022 (PPI-OT): Banks: Quantifying the fear of budget measures
Pak Banks are down 9% YTD and 6% MTD due to fear of unfavourable budgetary measures. While there are no details, we look at historical precedents, where banks have been subjected to higher tax (corporate and/or Super Tax) and higher tax on income from govt securities. We quantify the impact of each of these measures’ ranges from 9-13% on CY23E earnings.
On our base case, CY22E/CY23F ROE (Tier I) is expected to average at 21%/26%; last seen during CY06/07. On the other hand, current multiples reflect a more than 75% discount to P/B seen in CY06/07. Even if we account for penal tax measures repeating, and take a 30% hit (extreme case) on CY23 earnings, valuations for banks are at 0.6x P/B and sub 4x P/E.
We reiterate our liking for Pak Banks, maintaining our Overweight stance, where the sector also offers a D/Y of 9%. Our top pick in the sector remains United Bank Limited (UBL), Bank Alfalah (BAFL) and Meezan Bank (MEBL).
Anticipated harsh measures more than priced in
Pak Banks have reported a negative return of 9% YTD and 6% MTD on concerns over anticipation of unfavourable budgetary measures on the sector. The underperformance has led to sector’s multiples dropping to all-time lows, despite expanding ROEs. We illustrate historical multiples of the banking sector that have broadly been correlated to the sector’s ROEs. At present, the sector’s ROEs are expected to jump to a 16-year high. CY22E/CY23F ROE (Tier I) is expected to average at 21%/26%, which was last seen during CY06/07. On the other hand, current multiples reflect a more than 75% discount to P/B the sector traded in CY06/07.
While it is understood that market participants fear hefty taxes to be placed on the banking sector over expanding profits earned by the sector in the ongoing monetary tightening environment, we believe the massive discount reflects more than quantitative factors, and negative sentiments regarding uncertainty over macro decisions have a key role as well.
ROEs at 6-year high even in the worst-case scenario
To understand the intensity of potential tax measures on the sector, we pick precedents from earlier budgetary measures and compute the sector’s Tier I ROE and P/B post any harsh measures. We present scenarios with application of (1) every 5% additional corporate tax (or Super Tax) and (2) every 5% additional tax on income from Federal Government Securities.
To recall, the banking sector has faced Corporate Tax as high as 58% until 2001, which was then gradually reduced over the years. Moreover, the government has also penalized banks for placing higher deposits in Federal Government securities in 2018/2019 through higher taxes on the income from the same.
While impact on each bank is broadly similar, measures that are pinned to investment levels have a relatively higher impact on banks with (1) low ADR, (2) higher federal government securities to Deposits and (3) low Non-Interest Income to PAT. We present the earnings contribution of different segments to interest income of different banks below.
Even if we account for the penal tax measures repeating themselves, and take a 30% hit (extreme case) on CY23 earnings, valuations for banks are at 0.6x P/B and sub 4x P/E. In the 30% earning cut scenario, the sector’s Tier I ROE still comes to 19%, highest since CY16.
Overweight stance maintained
We reiterate our liking for Pak Banks, maintaining our Overweight stance, where we expect earnings to grow at a 3-year CAGR of 14% (+31% YoY in CY22E) on the back of improvement in Net Interest Income (NII) coupled with growth in fee income. Our base case accounts for monetary easing in CY23, taking the Policy Rate down to 9.75%.
We believe these concerns are somewhat overplayed as change in asset mix and early play of higher yields have improved the sector’s return generation potential, making current multiples attractive even with incorporation of higher taxation measures.
The sector trades at an attractive CY22E P/B of x0.6x and offers a D/Y of 9%. Our top pick in the sector remains United Bank Limited (UBL), Bank Alfalah (BAFL) and Meezan Bank (MEBL), offering a mix of higher capital upside as well as attractive D/Y.