Karachi, November 15, 2022 (PPI-OT): BAHL: Superior ROE ignored in current multiples, Buy

Following 8% underperformance vs KSE100 Index over FY23TD, we believe Bank Al Habib provides an attractive opportunity as current multiples ignore (1) recurring Tier I ROE at 23% (conventional banks: 19%) and (2) superior asset quality.

In light of management comments shared in BAHL’s Corporate Briefing session yesterday, we leave relatively higher deposit growth estimates intact, albeit with higher admin expense growth.

As management targets slower branch expansion from CY23F, a potential higher growth in revenues compared to expenses i.e. ‘positive operating jaws’ impact would further support its ROE, currently not a part of our base case.

Underperformance provides opportunity at current levels

We re-iterate Buy on Bank Al Habib Ltd (BAHL) with a TP of Rs130, offering 2x upside from current levels. Following 8% underperformance vs KSE100 Index over FY23TD, we believe the stock provides an attractive investment opportunity. We believe BAHL’s current multiples are undervalued owing to (1) recurring Tier I ROE at 23% (conventional banks: 19%) and (2) superior asset quality of the bank. The stock currently trades at a CY22E P/B of 0.65x. Nonetheless, focus on growth may keep the stock’s D/Y lower than peers, along with limited cushion to minimum adequacy ratios (CET I: 9.6%, Tier II: 13.4%). We expect the bank to continue maintaining a higher leverage (assets as a multiple of equity at 21x vs 17x for peers). Hence, despite ROA at par to peers, BAHL is likely to keep generating higher ROE.

Asset mix tilted to variable rate instruments

The Investment book is broadly parked in Government Securities with 62% in PIB Investments and 21% in T-Bills as at Sep-2022. More than half of the PIB Investment book is estimated to be parked in PIB floaters; while remaining in fixed PIB papers that has a duration of around 2 years. On the Advances front, BAHL continued higher lending book expansion, keeping Gross ADR at 52%. While CY22E/23F is expected to continue with macro challenges on the asset quality front, the bank is well covered for any unforeseen events. At present, BAHL’s Gross Infection ratio stands at 1.1%, while Coverage ratio is at 154% through General Provisions. On the Investment book, the bank has partially provided for Sri Lankan bond investment, as required by IFRS 9 and will assess at 4Q end for any further provision requirement.

‘De-operating leverage’ impact – a potential benefit

In light of management comments shared in BAHL’s Corporate Briefing session yesterday, we leave relatively higher deposit growth estimates intact. To note, BAHL reported 23% YoY growth in zero-cost Deposits during 3QCY22, keeping mix intact at 38%. Our base case projections incorporate a similar mix and we maintain the same for now. The management shared target of opening 123 branches in CY22, out of which 112 branches have been opened so far, making the run rate of opening a new branch every 2 to 3 days. The same is also reflected in its Cost to Income ratio, which stands at 52%, higher than peer average of 46%.

For CY23E, management targets to taper its network expansion growth as it believes that it is optimally located in most places now. With a target of 50 branches, we expect the bank’s high growth in Administrative Expenses to soften in coming years. Hence there is a likelihood of the bank’s high Cost to Income ratio to gradually decline from CY23E led by (1) improving Total Income and (2) declining growth of operating expenses. This faster growth of revenues vs growth in operating costs i.e. ‘positive operating jaws’, not a part of our base case at present, would give BAHL an added advantage over other banks, further supporting its earnings growth and enhancing its ROE.