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UBS Investment Research
UBS Key Calls – Asia ex-Japan
O ur highest conviction ideas
What are Key Calls?
Key Calls represent our highest conviction single stock research ideas across the
region. The list is designed to generate bottom-up ‘alpha’ and is not a portfolio that
we use to express our top-down view. The key selection criteria are analyst
conviction, liquidity (more than US$10m average daily turnover for most stocks),
and a strategy overlay in terms of the macro outlook, market positioning and risk
management.
Equity strategy view
In the short-term, we expect continued weakness as economic data remains
volatile. However, we still expect data to stabilise into September, which from a
cyclical perspective, should help Asian equities. As a result, with sentiment washed
out, and our expectation that data will improve into the final stretch of this year, we
expect Asian equities to end the year higher than they are today, but to remain
weak in the short term.
Our live Key Calls
We have eight live Asia Key Calls: Cheung Kong Infrastructure (CKI); China
Unicom - H; Federal Bank; Industrial & Commercial Bank of China (ICBC – H);
KEPCO; Li & Fung (Sell); OCBC; and Sun Hung Kai Properties (SHKP).
Key Calls represent our highest conviction single stock ideas. The list is
designed to generate bottom-up ‘alpha’. It is not a balanced, index-tracking
portfolio that we use to express our top-down view. It combines our analyst and
strategy views—with an emphasis on the former—while taking into account our
views on the macro backdrop and market positioning.
Criteria for Key Call selection
We select our Key Calls based on the following criteria.
Analyst conviction. This is the most important criterion given the bottom-up
nature of our Key Calls. The primary consideration is the strength of the
individual stock investment case. In many instances, this also translates into
significant upside/downside in our price targets.
Liquidity. We set a minimum threshold of US$10m in average daily trading
turnover over the past three months. We make exceptions for strong ideas,
particularly in the smaller markets.
Strategy overlay. Key Calls are bottom-up driven and as such, they are not
selected on the basis of how well they fit our top-down views. That said, we
apply a top-down overlay on our stock selection in terms of the macro
outlook, market positioning and risk management. In practical terms, if we
hold a cautious view on the market for instance, this will not stop us from
selecting a high-beta stock with a strong company-specific investment case
as a Key Call. However, it will likely mean that the Key Call list will be
more weighed to defensive rather than high-beta stocks.
Summary of our strategy view
Our year-end target is now 580 on the MSCI Asia ex Japan index. This implies a
return of 10% from end-August levels. This would bring Asia ex Japan close to
2x price-to-book and 12x forward earnings by year end. This would leave Asian
equities about 15% below their long-run forward PE multiples.
In the short-term, we expect continued weakness as economic data remains
volatile. However, we still expect data to stabilise into September, which from a
cyclical perspective should help Asian equities. As a result, with sentiment
washed out and our expectation that data will improve into the final stretch of
this year, we expect Asian equities to end the year higher than they are today,
but to remain weak in the short term.
Our key country picks are India, where we think policy headwinds may peak
and earnings risks are now beginning to be reflected in estimates, and China,
which we see as a market that should benefit from falling inflation. We have
underweight positions in Korea and Taiwan as we think slowing global growth
will remain a headwind. We are neutral on Thailand to reflect the increasing
political uncertainties due to the upcoming elections. In general, the Association
of Southeast Asian Nations (ASEAN) markets appear to be least at risk from a
growth slowdown and could benefit from subsiding inflationary fears. We are
neutral on those markets due to their relatively expensive valuations.
Why is Federal Bank a Key Call?
Federal Bank is a private sector bank (established in 1931) with 746 branches (60%
in Kerala) and a balance sheet of Rs527bn, with market cap of US$1.4bn. We
believe Federal Bank is on the brink of an operations turnaround catalysed by a
change in leadership and a structural improvement in asset quality. We expect the
new CEO’s focus on improving the contribution of fee-based income (one of the
lowest in the industry) to offset a cyclical decline in NIMs, while a pickup in asset
growth and lower credit costs could support an earnings CAGR of 27% over FY11-
13, which is one of the highest in the industry.
Further Data
Current Price Rs383.05
Market Cap US$1.42bn
Av. Daily Value US$4.8mn
Forecast Dividend Yield 2.1
Net Cash (debt) NA
Bloomberg code FB IB
Reuters code FED.BO
Consensus (Bloomberg)
Buy 23
Neutral 1
Sell 1
’12 EPS median 41.5
’12 EPS range 34.3 - 48.7
The Buy Case
(1) Federal Bank has all the ingredients of a newer private sector bank (those licensed in the 1990s): Federal Bank is
an older private sector bank with 746 branches and access to a unique non-resident Indians (NRI) customer base.
Trading at 1.0x FY13E book and 7x FY13E earnings, we think it is one of the cheapest private sector banks in India with
the potential to re-rate to the level of its newer private sector bank peers (which are trading at 1.6x-3.3x book).
(2) New management team all set to transform the bank franchise: Federal Bank earns high NIMs of 3.9% (Q1 FY12),
which is supported by its low-cost deposit base of around 33% and its small and medium enterprises (SME) loan book. It
struggled with high non-performing loan (NPL) additions and slower growth in the past, but we think this should change with
a new management team on board. We expect the new management team to significantly enhance the bank’s franchise in
the next few years by improving its risk management systems, adding fee products, and fostering a performance-based
incentive culture among its staff.
(3) Expect improvement in franchise to drive re-rating: We expect loan-loss provisioning (LLP) to decline despite industry
pressure, from 1.8% in FY11 to 1.2% in FY13, and a 36% fee CAGR over FY11-13, supporting an ROE expansion from
12% currently to 16% by FY13. We forecast an earnings CAGR of 27% over the same period due to falling NPL provisions
and an improving revenue profile. The stock is trading at a 50-60% discount to the private sector banks; we expect this to
narrow in the coming years. We believe Federal Bank could be a potential M&A candidate given the Reserve Bank of
India’s (RBI) plan to award new bank licences.
Key issues/risks
(1) We believe the risks include a delay in execution by the new management due to a lack of co-operation from the
unionised employees. We believe friction between management and employees has reduced over the years due to
open communication channels, performance-based incentives, and technology. However, we think it remains the
biggest impediment for the bank to scale up in line with private sector banks. A systemic deterioration in asset quality
could also delay the bank’s NPL recovery.
Catalysts
Improvement in asset quality from Q2 FY12: We believe the market is extrapolating current asset quality in future too; we
expect non-performing assets (NPA) to improve with a slowdown in NPA additions and an improvement in recoveries from
Q2 FY12 onwards.
Improvement in ROA: With declining credit costs, we expect ROA to improve from 1.3% in FY11 to 1.4% in FY13 even
though we have built in a decline of 40bp in NIM.
Potential M&A candidate: We believe new banking licences, which could be awarded in the next 12-18 months, could
trigger M&A in the sector and Federal Bank could be a potential M&A candidate given it is a private sector bank with
inexpensive valuations.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
UBS Key Calls – Asia ex-Japan
O ur highest conviction ideas
What are Key Calls?
Key Calls represent our highest conviction single stock research ideas across the
region. The list is designed to generate bottom-up ‘alpha’ and is not a portfolio that
we use to express our top-down view. The key selection criteria are analyst
conviction, liquidity (more than US$10m average daily turnover for most stocks),
and a strategy overlay in terms of the macro outlook, market positioning and risk
management.
Equity strategy view
In the short-term, we expect continued weakness as economic data remains
volatile. However, we still expect data to stabilise into September, which from a
cyclical perspective, should help Asian equities. As a result, with sentiment washed
out, and our expectation that data will improve into the final stretch of this year, we
expect Asian equities to end the year higher than they are today, but to remain
weak in the short term.
Our live Key Calls
We have eight live Asia Key Calls: Cheung Kong Infrastructure (CKI); China
Unicom - H; Federal Bank; Industrial & Commercial Bank of China (ICBC – H);
KEPCO; Li & Fung (Sell); OCBC; and Sun Hung Kai Properties (SHKP).
Key Calls represent our highest conviction single stock ideas. The list is
designed to generate bottom-up ‘alpha’. It is not a balanced, index-tracking
portfolio that we use to express our top-down view. It combines our analyst and
strategy views—with an emphasis on the former—while taking into account our
views on the macro backdrop and market positioning.
Criteria for Key Call selection
We select our Key Calls based on the following criteria.
Analyst conviction. This is the most important criterion given the bottom-up
nature of our Key Calls. The primary consideration is the strength of the
individual stock investment case. In many instances, this also translates into
significant upside/downside in our price targets.
Liquidity. We set a minimum threshold of US$10m in average daily trading
turnover over the past three months. We make exceptions for strong ideas,
particularly in the smaller markets.
Strategy overlay. Key Calls are bottom-up driven and as such, they are not
selected on the basis of how well they fit our top-down views. That said, we
apply a top-down overlay on our stock selection in terms of the macro
outlook, market positioning and risk management. In practical terms, if we
hold a cautious view on the market for instance, this will not stop us from
selecting a high-beta stock with a strong company-specific investment case
as a Key Call. However, it will likely mean that the Key Call list will be
more weighed to defensive rather than high-beta stocks.
Summary of our strategy view
Our year-end target is now 580 on the MSCI Asia ex Japan index. This implies a
return of 10% from end-August levels. This would bring Asia ex Japan close to
2x price-to-book and 12x forward earnings by year end. This would leave Asian
equities about 15% below their long-run forward PE multiples.
In the short-term, we expect continued weakness as economic data remains
volatile. However, we still expect data to stabilise into September, which from a
cyclical perspective should help Asian equities. As a result, with sentiment
washed out and our expectation that data will improve into the final stretch of
this year, we expect Asian equities to end the year higher than they are today,
but to remain weak in the short term.
Our key country picks are India, where we think policy headwinds may peak
and earnings risks are now beginning to be reflected in estimates, and China,
which we see as a market that should benefit from falling inflation. We have
underweight positions in Korea and Taiwan as we think slowing global growth
will remain a headwind. We are neutral on Thailand to reflect the increasing
political uncertainties due to the upcoming elections. In general, the Association
of Southeast Asian Nations (ASEAN) markets appear to be least at risk from a
growth slowdown and could benefit from subsiding inflationary fears. We are
neutral on those markets due to their relatively expensive valuations.
Why is Federal Bank a Key Call?
Federal Bank is a private sector bank (established in 1931) with 746 branches (60%
in Kerala) and a balance sheet of Rs527bn, with market cap of US$1.4bn. We
believe Federal Bank is on the brink of an operations turnaround catalysed by a
change in leadership and a structural improvement in asset quality. We expect the
new CEO’s focus on improving the contribution of fee-based income (one of the
lowest in the industry) to offset a cyclical decline in NIMs, while a pickup in asset
growth and lower credit costs could support an earnings CAGR of 27% over FY11-
13, which is one of the highest in the industry.
Further Data
Current Price Rs383.05
Market Cap US$1.42bn
Av. Daily Value US$4.8mn
Forecast Dividend Yield 2.1
Net Cash (debt) NA
Bloomberg code FB IB
Reuters code FED.BO
Consensus (Bloomberg)
Buy 23
Neutral 1
Sell 1
’12 EPS median 41.5
’12 EPS range 34.3 - 48.7
The Buy Case
(1) Federal Bank has all the ingredients of a newer private sector bank (those licensed in the 1990s): Federal Bank is
an older private sector bank with 746 branches and access to a unique non-resident Indians (NRI) customer base.
Trading at 1.0x FY13E book and 7x FY13E earnings, we think it is one of the cheapest private sector banks in India with
the potential to re-rate to the level of its newer private sector bank peers (which are trading at 1.6x-3.3x book).
(2) New management team all set to transform the bank franchise: Federal Bank earns high NIMs of 3.9% (Q1 FY12),
which is supported by its low-cost deposit base of around 33% and its small and medium enterprises (SME) loan book. It
struggled with high non-performing loan (NPL) additions and slower growth in the past, but we think this should change with
a new management team on board. We expect the new management team to significantly enhance the bank’s franchise in
the next few years by improving its risk management systems, adding fee products, and fostering a performance-based
incentive culture among its staff.
(3) Expect improvement in franchise to drive re-rating: We expect loan-loss provisioning (LLP) to decline despite industry
pressure, from 1.8% in FY11 to 1.2% in FY13, and a 36% fee CAGR over FY11-13, supporting an ROE expansion from
12% currently to 16% by FY13. We forecast an earnings CAGR of 27% over the same period due to falling NPL provisions
and an improving revenue profile. The stock is trading at a 50-60% discount to the private sector banks; we expect this to
narrow in the coming years. We believe Federal Bank could be a potential M&A candidate given the Reserve Bank of
India’s (RBI) plan to award new bank licences.
Key issues/risks
(1) We believe the risks include a delay in execution by the new management due to a lack of co-operation from the
unionised employees. We believe friction between management and employees has reduced over the years due to
open communication channels, performance-based incentives, and technology. However, we think it remains the
biggest impediment for the bank to scale up in line with private sector banks. A systemic deterioration in asset quality
could also delay the bank’s NPL recovery.
Catalysts
Improvement in asset quality from Q2 FY12: We believe the market is extrapolating current asset quality in future too; we
expect non-performing assets (NPA) to improve with a slowdown in NPA additions and an improvement in recoveries from
Q2 FY12 onwards.
Improvement in ROA: With declining credit costs, we expect ROA to improve from 1.3% in FY11 to 1.4% in FY13 even
though we have built in a decline of 40bp in NIM.
Potential M&A candidate: We believe new banking licences, which could be awarded in the next 12-18 months, could
trigger M&A in the sector and Federal Bank could be a potential M&A candidate given it is a private sector bank with
inexpensive valuations.
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