OCBC: accumulate on weakness

In the wake of undershooting 4Q08 earnings and a worse-than-expected GDP growth trajectory, as underpinned by our recent Singapore FY09F GDP growth downgrade, from -1% to -5%, we have cut FY09F-10F earnings by 16-23%. This reflects the net effect of the following revisions: increase in the group net interest margin (NIM) estimate for FY09F, from 2.15% to 2.37% (FY08: 2.27%), reflecting the positive combination of broadly rising average loan spreads, steeper yield curve and more favourable deposit mix; ii) a sharp increase in net asset (loan and securities) loss provisioning for FY09F, from 60bps to 100bps, as asset quality deterioration reflects reduced GDP growth forecasts; iii) reduction in loan growth expectations, from +6% to +2%, primarily reflecting the weaker GDP environment and reduced working capital requirements, particularly for export-related industries; and iv) a reduction in growth expectations for reported non-interest income (NII) over FY09F, from -3% to -12% (core NII flat y-y, helped by stabilising insurance contributions), as capital market-related weakness extends even as commercial banking fee-related volumes come off.

Supported by ample capital and sustained profitability, management has guided that the absolute dividend payment (FY08: 28 cents net) is unlikely to decline by the same pace as earnings. We are conservatively forecasting that dividend payouts will decline to 20 cents net in FY09, equivalent to an earnings payout of 50%, which is similar to the payout for FY08 – should the dividend for FY09 be maintained at 28 cents a share, the effective earnings payout would be closer to 70% of forecast earnings.

In line with the reduction in forecast book value formation over FY09F and a cut in our sustainable ROE input for the Gordon growth-based valuation model, from 10% to 9%, to reflect the relatively cautious forecast deployment of an overflowing capital base, our Gordon growth-based target price (methodology unchanged: assumptions being 9% sustainable ROE, 9% cost of capital (from 10% previously to reflect the interim decline in risk-free rates as derived from the five-year government bond yield), 5% long-term growth) is adjusted lower, from S$5.60 to S$5.30, or 1.0x stated book value, or 13x FY09F earnings (see Exhibit 6 for the regional valuation comparison).

OCBC fits the bill as a quality low-beta exposure to the Singapore banks sector, underpinned by a tight operational footprint and ample capital reserves. While larger-than-peer property sector exposure is a concern, risk management appears robust and, unlike the Asian Financial Crisis, credit assessment has had substantial lead time to adjust to expectations of declining property prices. The life insurance operation via GE, notwithstanding a volatile 2008, is fundamentally a low-beta business and with capital markets stabilising, investment returns should flatten out in parallel and reaffirm this reality – a move to privatise GE should be positively received given attractive valuations. With high-conviction yields exceeding 4% and well-supported, investors seeking a relatively low-risk exposure to the sector should look to accumulate on weakness.

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