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Ringing in the Cash

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Ringing in the Cash Sri Lanka | Banks, Finance and Insurance EQUITY RESEARCH Initiation of coverage 25 July 2014 Sampath Bank PLC (SAMP.N0000) Pawning woes nearing end: Focus on 2015 We expect the overhang on Sampath Bank (SAMP) shares to recede further on the Key statistics easing of concerns regarding its pawning portfolio and its ability to derive growth CSE/Bloomberg tickers SAMP.N0000/SAMP SL from alternative credit lines. SAMP is trimming its pawning portfolio to below 15% Share price (24 July 2014) LKR213 of total loans by 2Q14E (from 25% in December 2012). The significant increase in No. of issued shares (m) 168 customer contact following the near doubling of the number of branches (of which Market cap (USDm) 275 95% are now profitable) should enable SAMP to derive greater revenue growth. We Free float (%) 85% expect 2015E and 2016E to be turnaround years for SAMP, with double-digit credit 52-week range (H/L) LKR218/162 and income growth, and a recovery in ROE. As the third-largest private Avg. daily vol. (shares, 144,218 commercial bank, with an asset base of LKR388bn and market cap of LKR36bn, 1yr) SAMP should be a beneficiary of the low interest rate regime-driven recovery in Avg. daily turnover 199 credit growth. Tailwinds from improving macroeconomic fundamentals, favorable (USD’000) policies such as the Central Bank of Sri Lanka’s (CBSL’s) guarantee for gold Source: CSE, Bloomberg loans, and benign inflation should provide further impetus. Our P/B- and P/E- Note: USD/LKR=131.0 (average for the year ended 24 July based analyses suggest a valuation range of LKR210-243. 2014) The underlying long-term economic growth story remains intact: Structural factors Share price movement driving the banking sector’s growth story remain solid, in our view. A simple back-of-the- 120% envelope calculation supports the case for double-digit loan growth. GDP growth of 7% and inflation of 5% imply nominal economic growth of roughly 12%. Credit growth is 110% typically 2-3ppts higher than nominal growth; 14-15% is thus feasible. This view is substantiated by Sri Lanka’s low private-sector credit-to-GDP ratio (29% in 2013) 100% compared with peers’, low mortgage lending and personal credit levels, indicating further room for growth. 90% The benefits of a low interest rate regime are yet to flow through: Restraints imposed by the CBSL to rein in over-lending on gold-based loans, combined with the 80% Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 timing difference as corporates and investors re-adjust to the low interest rate regime, SAMP ASPI S&P SL 20 appear to be behind the currently lackluster credit environment. The banking sector reported loan book growth of 8.8% in 2013 and 5.1% in 1Q14. Furthermore, although Source: CSE, Bloomberg policy rates have been on a downward trajectory since mid-2013, banks have been slow Share price performance to reduce lending rates (prime lending rates remained in the double digits as recently as in June 2014). We expect credit growth to pick up in 2H14E as the benefits of a rate 3m 6m 12m reduction flow through; the downward trajectory in rates should also benefit banks’ asset SAMP 11.6% 19.1% 6.3% quality. S&P SL 20 11.0% 8.3% 9.3% More than one string to its bow: We expect SAMP to continue to show significant loan All Share Price Index 9.8% 8.4% 11.6% growth in segments other than pawning, in line with the sector’s recovery (gross loans, excluding pawning, grew 17% YoY in 1Q14 on strong contributions from term loans, Source: CSE, Bloomberg overdrafts and leases, enabling 14% YoY overall loan growth despite a LKR9bn Summary financials contraction in pawning). We expect the cutback in gold-based loans to be less severe than projected given the lower interest rate regime and the guarantee scheme established by LKRm (year-end 31 the CBSL, which should mitigate risks. We also expect continued improvements in the December) 2013 2014E 2015E cost-to-income ratio as the new branches mature. Moreover, during the remainder of 2014, Net interest income 15,095 11,624 13,659 reported earnings should receive a one-off boost from the reversal of the “big-bath” Net revenue 20,360 17,779 20,585 impairment provisioning in 2013. We forecast loan growth at a 12% CAGR and EPS Operating profit 5,720 6,437 7,163 growth at a 17% CAGR over 2014E-2016E. PBT 4,789 5,343 5,945 We establish a valuation range of LKR210-243: SAMP’s shares currently trade at a Net income 3,635 3,839 4,276 P/B multiple of 1.1x, in line with its two-year historical average. We expect the market to Recurrent EPS 21.7 22.9 25.5 value SAMP at a higher multiple as current concerns ease; however, as a base case, we ROE (%) 12.2 11.7 12.1 conservatively value SAMP at 1.1x one-year forward BVPS. We cross-check this value by assigning a P/E multiple of 9.3x to its one-year forward EPS, in line with the current P/B (x) 0.9 1.1 1.0 multiple. A sensitivity analysis of the assigned base-case multiples yields a valuation Source: SAMP, Copal Amba estimates range of LKR210-243. 1 A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba Sampath Bank PLC Table of Contents Overhang due to pawning woes is receding ........................................................................................................................ 3 The largest pawning portfolio among private commercial banks .......................................................................................................... 3 A smaller impact from high-risk loans after 3Q14E ............................................................................................................................... 3 Conservative provisioning and intensified collateral value realization .................................................................................................. 4 More than one string to its bow ............................................................................................................................................ 6 Gross loans excluding pawning grew 35% YoY in 2013 ....................................................................................................................... 6 Increased focus on non-interest income growth ................................................................................................................................... 7 Efficiency gains to further support profitability ..................................................................................................................... 8 Improvement in the CIR as new branches mature ................................................................................................................................ 8 Technological innovation could support further cost reduction ............................................................................................................. 8 Sustainable growth in a low interest rate environment ........................................................................................................ 9 Double-digit loan growth and lower provisioning to compensate for NIM compression ........................................................................ 9 Current concerns about the banking sector are short-term ............................................................................................... 11 Private sector credit growth rate declined due to a confluence of negative factors ............................................................................ 11 Stimulation from lower interest rate regime yet to gain momentum .................................................................................................... 13 Pawning portfolio issues managed effectively .................................................................................................................................... 14 Industry average measures mask wide variations in individual bank performance............................................................................. 15 Lower SOE borrowings support private credit growth ......................................................................................................................... 16 Improving liquidity levels ease pressure on interest rates .................................................................................................................. 17 Banking sector loan book well diversified ........................................................................................................................................... 17 Macroeconomic factors substantiate private sector credit growth story ............................................................................ 18 Credit as a percentage to GDP well below that of regional peer set................................................................................................... 18 IMF forecasts Sri Lanka’s GDP to be the highest in the region .......................................................................................................... 19 Inflation targeted to remain at mid-single digit levels .......................................................................................................................... 19 FDI inflows continue to rise................................................................................................................................................................. 20 Foreign remittances and exports increasing ......................................................................................................................................
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