Bank Alfalah Limited – Hold Call with Dec-11 PT of PKR11/share

Initiating coverage on BAFL with Dec-11 PT of PKR11/share: We recommend a HOLD call on BAFL, as Return on Equity is expected to remain lower than the Cost of Capital. The scrip currently offers a limited upside of 2% to our PT and is trading at a CY11E P/E and P/BV of 6.6x and 0.5x respectively.

Consolidation in consumer, ADR to be maintained around 68%: BAFL’s market niche, consumer banking, has been consolidating since CY08, owing to the economic downturn coupled with reduction in purchasing power of consumers. We expect the management to remain conservative on lending side, prime focus being towards risk-averse investments. Advances are expected to witness a 6% CAGR over CY10-13.

Deposits to grow at a CAGR of 6% but at a higher cost: Given low share of CASA (averaging 57%) in total deposit mix, we expect interest expense to remain comparatively higher going forward. Opening of approx. 20 branches per annum (including 10 Islamic branches) in next two years along with gradual increase in CASA could reduce cost of funds to some extent.

NPL provisioning to take toll on profitability: Although, the bank is striving hard to contain further accretion in bad loans, we expect the upward momentum to continue in future, given slow economic recovery. Gross Infection Ratio is expected to settle at 8% till CY13 down from the present 9.1% level, with NPLs growing at a CAGR of 1% over CY10-13.

Other developments: BAFL is expected to book further impairment of PKR800mn in 4QCY10 (PKR500mn charged in 3Q), which we have already incorporated in our CY10E EPS of PKR1.19. On Islamic banking front, the bank so far does not have any plans to separate its Islamic banking as a subsidiary.

Valuation risks: Key valuation risks include 1) Gradual uptick in NPLs; resulting in more than estimated provisions and 2) Branch network expansion, which would keep intermediation cost high.

Initiating coverage on BAFL with Dec-11 PT of PKR11/share

We initiate coverage on Bank Alfalah Limited (BAFL), with a HOLD stance and December 2011 Price Target of PKR11/share, as the Return on Equity is expected to remain lower than the Cost of Capital in the near term. Our recommendation is further supported by the assumption that the bank’s bottom-line is expected to maintain a low CAGR of 27% over CY10-13 compared to a CAGR of 42% witnessed in the booming era of CY04-CY07. Consolidation on lending side (mainly in consumer financing) and comparatively costlier deposits against peers resulting in reduced spreads, gradual accretion in NPLs and slowdown in commission and brokerage income could throttle future profitability growth. The scrip currently offers limited upside of 2% to our PT and is trading at a CY11E P/E and P/BV of 6.6x and 0.5x respectively. HOLD!

Consolidation in consumer, ADR to be maintained around 68%

BAFL’s advances observed a healthy CAGR of 22% over CY04-08, outpacing industry’s lending CAGR of 17%, primarily due to bank’s aggressive penetration into the consumer segment. However, due to unabated rise in infected loans owing to the economic downturn coupled with reduced purchasing power of consumers, the management decided to consolidate the portfolio. Hence, although the bank managed to sustain CY08 level of PKR197bn in advances during CY09, consumer financing plunged by 19% YoY (we have assumed ‘Individuals’ as total consumer portfolio in BAFL’s case). Nevertheless, due to same pace decline in the industry’s consumer segment, BAFL maintained 13% market share in the total chunk. Going forward, we expect the management to remain conservative on the lending side, with advances growing at a 6% CAGR over CY10-13 (Gross ADR estimated to be around 68%), and prime focus being towards liquid and risk-averse investments.

Deposits to grow at a CAGR of 6% but at a higher cost

Growth in funds, CAGR of 10% over last five years, has come from high rates being offered to the depositors. This has resulted in low share of CASA (averaging 57% in last 5 years and down to 54% in last 2 years) in the total deposit mix. BAFL’s cost of funds stood at 7.0% in 9MCY10 compared to sector’s return on deposits of 5.9%. We expect cost of funds of the bank to remain comparatively higher going forward, in the vicinity of 7%. Opening of approx. 20 branches per annum (including 10 Islamic branches) in next two years along with management’s focus toward gradual increase in share of CASA could reduce cost of funds to some extent. Overall deposits of the bank are expected to grow at a CAGR of 6% over CY10-13.

NPL provisioning to take toll on profitability

NPLs rose by a hefty CAGR of 98% over CY05-09, as asset quality of the bank worsened due to increasing defaults in Textile sector’s advances in addition to consumer financing. Infected loans almost doubled in CY09 alone, to stand at PKR16.2bn and Gross Infection Ratio (GIR) also jumped to 8.2% from 4.5% in CY08. Although, the bank is striving hard to contain further accretion of bad loans, they continued to rise in 9MCY10 given slow economic recovery, with total infected portfolio reaching PKR19.0bn and GIR at 9.1%. We expect the upward momentum to continue in future, nevertheless at a low CAGR of 1% over CY10-13, and Gross Infection Ratio is expected to settle around 8% till CY13.

NFI’s share in total income on decline, intermediation cost to rise to 30%

The bank earned healthy non-funded income (NFI) in past (share in total income averaging 15%) on the back of generating good commissions on its consumer products, and was further supported by rise in FX and equity incomes. However, due to consolidation in consumer financing, coupled with lesser volatility in FX and steady rise in income from equity operations, NFI is expected to have on average 10% share in total income over CY10-13. Admin expenses, on the other hand, are likely to remain high due to ongoing branch network expansion and inflationary pressures. Hence, intermediation cost, is expected to rise to 30% from 27% at the end of CY09.

Other developments

BAFL had total impairment of PKR1.3bn at the start of CY09 against its investment in associate – Warid Telecom. The bank in this connection charged up to PKR500mn in 3QCY10 (EPS impact of PKR-0.37) and is expected to book further impairment of PKR800mn in 4QCY10 (EPS impact of PKR-0.59). We have already incorporated this charge in our CY10E EPS of PKR1.19. On Islamic banking front, the bank so far does not have any plans to separate Islamic banking from the conventional banking operations. Owing to continuous decline in industry’s share, the bank needs intensive efforts to sustain it.

Valuation risks

Key risks to our recommendation include 1) Gradual uptick in NPLs, resulting in more than estimated provisions and 2) Branch network expansion, which would keep intermediation cost high.

Economic & Political News

OMCs, dealers” fixed margin: government refuses to withdraw decision

The government has turned down the request of the oil marketing companies (OMCs) and dealers to withdraw its decision in respect of fixed margins on petroleum products despite one multinational OMC threatened to wind up business in case the decision was not overturned. Petroleum Secretary Imtiaz Qazi clarified that the Economic Co-ordination Committee (ECC) of the Cabinet had taken the decision to fix margins in the light of Judicial Commission Report and, therefore, the ministry could not revert it. Judicial Commission, led by Justice Bhagwan Das, had suggested fixing margins in absolute rupee terms, instead of percentage mode. The ECC subsequently approved fixed margins of OMCs and dealers in absolute rupees terms, instead of 3.5% and 4% respectively, implemented from December 1, 2010 as follows: PKR1.50/litre petrol, PKR1.72/litre HOBC (high octane blending component), PKR1.58/litre kerosene and PKR1.61/litre light diesel oil for OMCs. The dealers’ margin was fixed at PKR1.87/litre on petrol and PKR2.15/litre on HOBC.
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