IMS Coverage Initiation-Bank Alfalah Limited 13-01...

InterMarket Perspective

To find our Research on Bloomberg, please type - IMKP <GO>

13 January 2016

Abdul Ghani Fatani

Investment Analyst

[email protected]

+92-21-37131600- Ext 305

..

• We initiate coverage on Bank Alfalah Limited (BAFL), with a Buy rating, where our

Dec’16 TP of PkR35.2/share offers 20.3% upside (total return: 28.9%). Valuation

catch-up to the Big-5 (50% discount on P/B ex. NBP) has been a long posited theme

for BAFL and can now occur given emergent ROE convergence amidst drag on Big-5

banks.

• Our liking for BAFL is buttressed by an improved capital base (CAR: 14.1%) that can

support asset growth in a soft interest rate environment. With the Big-5 still

generally timid, BAFL’s growth plans in SME and Retail can enable outperformance

in the new business cycle while Islamic presence should payoff in the medium-term.

• Our CY16/17F EPS projections are 7%/5% higher than consensus estimates where

recent uptick in Coverage/CASA suggests management focus has tilted towards

profitability from BS growth earlier. We thus see still-high C/I (63%) as an

opportunity. BAFL trades at an attractive CY16F P/B of 0.83x and P/E of 5.74x where

full-year CY15F payout (3m D/Y: 8.5%) can catalyze price performance.

BAFL has arrived

Given its position as the sixth largest bank in Pakistan, the long posited theme for BAFL

has been one of eventual valuation convergence to the Big-5. It’s been a long time

coming, but we believe BAFL has finally arrived at the big stage. CASA is 71% vs. Big-5 avg.

of 75%; Coverage is close to 85% and CAR above 14% is sufficient. With ROE also close to

19% (vs. 20% for Big-5 ex-NBP), P/B valuation discount of 50% looks unjustifiably high,

particularly as cost efficiencies are likely to arise over the medium term.

Plugged into the new business cycle

A new business cycle has commenced with greater credit offtake a likely corollary; LT

private sector loans growth have already accelerated to 20%YoY. With the Big-5 eyeing

big-ticket project finance (where BAFL will also be involved) but still too timid to

aggressively venture into lower strata; BAFL has an open field to further entrench its

strong positioning in the SME/Commercial and Retail segments. At the same time,

medium-term Islamic banking prospects remain exciting, where we flag (i) win-win for

Islamic financing of GoP projects (Sukuks), and (ii) potential dedicated Islamic banking

subsidiary à-la MCB.

The timing is right

BAFL missed out in the last macro bull cycle (CY03-CY07) due to being in expansion mode

and then faced a prolonged period of tough macros. It now enters a higher-growth cycle

having completed its newest round of branch expansion (649 branches, 75 of which were

added after CY13 and are hitting profitability now). This means BAFL’s profits should be

able to withstand pressures from low interest rates/PIB re-pricing where our CY16/17F

EPS projections are 7%/5% higher than consensus estimates. Positive earnings surprises

can come into play via: (i) one off gains from Warid deal, (ii) capital gains on investments,

and (iii) earlier-than-expected materialization of cost efficiencies.

Intermarket Perspective BAFL trades at a CY16F P/B of 0.83x and P/E of 5.74x, at a discount of 50% to peers

despite similar ROE and potential for faster growth. Our Dec’16 TP of PkR35.2/share

offers 20.3% upside (total return: 28.9%) and implies a Buy stance, where upcoming

CY15F dividend can catalyze price performance (3m D/Y: 8.5%). Risks emanate from (i)

possible capital deficiency, if profits fail to meet projections, (ii) regulatory steps to further clip spreads and (iii) any lasting increase in C/I from current levels.

It’s been a long time coming… Initiate with Buy!

Bank Alfalah Limited

Bank Al-Falah Limited

Price (PkR/sh) 29.25

TP (PkR/sh) 35.19

Stance BUY

Upside 20.3%

Fwd D/Y 8.5%

Total Return 28.9%

Bloomberg / Reuters BAFL PA / BAFL.KA

Mkt Cap (US$mn) 443.1

52wk Hil-Low (PkR/sh) 34.24-23.9

12m Avg. Daily Vol ('000 shrs) 1,378

12m Avg. Td Val (US$mn) 0.383

Key Financial Snapshot

CY14A CY15F CY16F CY17F

EPS (PkR) 3.55 5.02 5.10 5.31

EPS Growth 20.6% 41.2% 1.7% 4.1%

PER (x) 8.25 5.84 5.74 5.52

BVS (PkR) 28.23 33.69 35.28 37.53

P/B (x) 1.04 0.87 0.83 0.78

NIMs 4.16% 4.23% 3.84% 3.88%

ROE (average) 14.7% 16.2% 14.8% 14.6%

ROE (Tier-I) 17.1% 19.8% 18.1% 17.2%

DPS (PkR) 2.00 2.50 2.50 2.75

Dividend yield 6.8% 8.5% 8.5% 9.4%

Payout Ratio 56.3% 51.0% 51.0% 48.0%

Source: IMS Research

BAFL vs. KSE100 Index

-40%

-20%

0%

20%

Jan

-15

Mar

-15

Jun

-15

Au

g-1

5

Oct

-15

Jan

-16

BAFL KSE100 Index


2 | P a g e

Perspective

Company Profile Owned by the Abu Dhabi Group, BAFL is the sixth largest bank in Pakistan, operating in

222 cities across Pakistan, with a network of 649 branches. In addition, the bank also has

small presence in Afghanistan, Bangladesh and Bahrain. BAFL was incorporated as a

public limited company in 1992 and commenced operations in Pakistan in 1997. BAFL is a

full service bank providing corporate, commercial, SME and retail services.

Commencement of operations 1997

Head Quarters Karachi

Sponsor group Abu Dhabi Group

Branches 649 (incl. 158 Islamic branches)

Network coverage 222 cities in Pakistan; 7 overseas

Deposit Market Share 6.5% (6th

largest)

Asset Base (PkRMn) 791,145

Advances (PkRMn) 302,112

Tier-I Capital (PkRMn) 41,284 Source: Company Accounts

Investment Thesis

BAFL stands out from peers whose stock price is being dragged by assorted reasons

including but not limited to (i) GCC exposure including Yemen for UBL, (ii) compliance

issues with HBL’s New York Branch, (iii) foreign selling in MCB, (iv) asset quality concerns for NBP and (v) lack of liquidity in ABL.

BAFL is the sixth largest bank in Pakistan; its size (and importantly capital: CAR: 14.1%)

now allows it to participate meaningfully in big-ticket syndicate financing while facing

limited competition from the Big-5 in the commercial & retail segments. This can enable outperformance in an improving economic setting, particularly as BAFL’s

operations are largely concentrated in Pakistan (93%).

Islamic operations account for 13% of BAFL’s business with Sukuks yielding Kibor or

lower. Given pipeline of big-ticket projects and push from SBP, potential higher demand for Sukuks may give rise to better margins on Islamic assets.

Unlike several medium-sized banks, BAFL has largely completed its branch expansion

phase well in advance of the current macroeconomic uptick. With branches in Pakistan

typically turning profitable in 1.5yrs, BAFL has timed its expansion well.

We project 5yr profit CAGR for BAFL at 14% with room for positive surprises on (i) one

off gains from Warid deal, (ii) capital gains on investments and (iii) earlier-than-

expected materialization of cost efficiencies.

BAFL trades at a CY16F P/B of 0.83x, P/E of 5.74x and D/Y of 8.5%. On P/B, BAFL trades

at a 35% discount to the Big-5 (50% discount ex-NBP) which appears unjustifiably high

given limited ROE differential – projected 5yr Tier-I ROE for BAFL is 18.3% vs. 21.9% on

average for the larger private banks.

Pattern of shareholding

Directors, CEO, etc. 14.50%

Associated Companies 4.40%

Mutual Funds 4.30%

General Public – Local 8.20%

General Public – Foreign 28.90%

Foreign Companies 27.10%

Others 12.60%

Advances Concentration

0%

20%

40%

60%

80%

100%

CY09 CY10 CY11 CY12 CY13 CY14

Agribusiness Textile Power Public/Govt Individuals Others

Source: Company Accounts

Advances Mix

58%21%

5%

11%5%

Corporate

Commercial

Consumer

Islamic

Overseas


3 | P a g e

Perspective

BAFL has arrived

Given its position as the sixth largest bank in Pakistan, the long posited theme for BAFL

has been one of eventual valuation convergence to the Big-5, similar to what has

occurred for HBL and UBL vis-à-vis MCB (17% discount now vs. 46% discount in CY07). It

has been a long time coming, but we believe BAFL has finally arrived. With CASA

(9MCY15: 71% vs. 61% in CY10), coverage (9MCY15: 84% vs. 55% in 9MCY10) and ROE

(9MCY15: 18.8% vs. Big-5 ex. NBP avg: 20.2%) converging to the top bank levels, and

CAR catching up (9MCY15: 14.1%), BAFL’s valuation discount (50% on P/B to Big-5 ex.

NBP) is not justified.

Unlike the other large banks that have been operating for several decades, BAFL with

less than 20yrs of existence, had to grow at a much quicker rate to catch up to the Big-5.

There was, therefore, an understandable compromise on Balance Sheet quality. Now,

however, BAFL is close to achieving its 700 branches target, which is coinciding with an

improvement in Balance Sheet metrics.

• BAFL’s NIMs are projected to average 4.1% in CY15-19F vs. 4.3% for the Big-5

• Provisioning coverage is 83% vs. 90% for the Big-5. Coverage was 55% in CY10.

• CASA has improved to 71% vs. 53% in CY09. Big-5 average is 75%.

• C/I is a high 61% vs. 44% for Big-5 but 9%YoY admin expense growth in 9MCY15

indicates this is now a focus area

• Tier-I ROE for CY15F-19F to average 18.3% vs. 21.9% for the Big-5 (ex-NBP). While

BAFL is more leveraged (15.4x vs. 9.6x for Big-5), its CAR is now above 14% vs. 18.4%

for Big-5. We flag that BAFL’s CAR is similar to UBL’s CAR.

Asset base approaching the PkR1tn mark…

0

400

800

1,200

1,600

2,000

0

500

1,000

1,500

2,000

2,500

HB

L

NB

P

UB

L

MC

B

AB

L

BA

FL

BA

HL

HM

B

AK

BL

MEB

L

FAB

L

PkRbn

Assets Branches (Rhs)


…while capital strength has improved

0%

5%

10%

15%

20%

25%

0

50

100

150

200

HB

L

NB

P

UB

L

MC

B

AB

L

BA

FL

BA

HL

HM

B

FAB

L

AK

BL

MEB

L

PkRbn

Total equity CAR (Rhs)


CASA & NIMs converging to top-tier level…

0%

20%

40%

60%

80%

100%

0%

1%

2%

3%

4%

5%

6%

MC

B

UB

L

HB

L

AB

L

NB

P

BA

FL

HM

B

AK

BL

FAB

L

BA

HL

MEB

L

NIMs CASA (Rhs)


…and Coverage has significantly improved

0%

40%

80%

120%

160%

0%

5%

10%

15%

20%

NB

P

HB

L

UB

L

AB

L

MC

B

BA

FL

BA

HL

MEB

L

AK

BL

HM

B

FAB

L

NPL Ratio Coverage (Rhs)


4 | P a g e

Perspective

Underappreciated deposit franchise

BAFL has significantly improved its CASA over time (71.1% in Sep’15 vs. 61.0% in CY10),

surpassing UBL, ABL and NBP in the process, and thereby narrowing its funding costs. As

a result, BAFL’s NIMs are now comparable to the Big-5. While management aims to

increase CASA to 80% in the long run, we conservatively expect it to remain in the 70%-

71% range over the next 5yrs. This still represents an excellent deposit franchise in our

view; which we believe the market is not yet appreciating – BAFL’s market cap/deposits

is 7.9% vs. 17.8% for the Big-5.

Higher coverage to contain credit costs

Over the last few years, BAFL has addressed a sore point of relatively weak asset quality

underpinned by low provisioning coverage. In this regard, the NPL ratio has come off to

5.8% vs. 9.1% in 3QCY10 while coverage is now more than 82% vs. 55% in 9MCY10. We

attribute this change to (i) focus on corporate business over last few years, (ii)

implementation of more stringent lending criteria and (iii) general economic uptick.

Going forward, while BAFL intends to expand its SME and Retail footprint, adequate

coverage together with a supportive macro backdrop suggests incremental credit costs

are likely to be limited.

CASA has significantly improved…

0%

2%

4%

6%

8%

10%

12%

14%

52%

56%

60%

64%

68%

72%

76%

CY10A CY11A CY12A CY13A CY14A CY15F CY16F CY17F

CASA KIBOR (RHS)

Source: Company Accounts & IMS Research

…but the market is not yet appreciating the deposit franchise

0%

5%

10%

15%

20%

Mkt Cap/Deposit

BAFL Medium Small Big-5


We see high C/I as an opportunity

0

5

10

15

20

0%

10%

20%

30%

40%

50%

60%

70%

MC

B

HM

B

AB

L

UB

L

HB

L

BA

HL

AK

BL

MEB

L

FAB

L

NB

P

BA

FL

Cost/Income Staff/Br. (Rhs)


ROE justifies a higher P/B multiple (9MCY15)

0.50

0.70

0.90

1.10

1.30

1.50

1.70

1.90

2.10

5.0% 10.0% 15.0% 20.0% 25.0% 30.0%

(PB

V-x

)

ROE (%)

MCB

UBL BAHL

BAFL

AKBL

NBP

MEBL

HBL

ABL

HMB

FABL


5 | P a g e

Perspective

We see high C/I as an opportunity

High administrative costs have historically been a drag for BAFL where Cost/Income has

averaged almost 65% over last 10yrs. However, there are signs of improvement where (i)

9MCY15 costs are up a contained 9%YoY, and (ii) branch expansion phase is largely over.

With the bank primed for scale efficiencies – staff/branch is down to 18 vs. 40+ in CY07 –

we expect C/I to trend lower over the medium to longer term. Potential for positive

surprises exist with our 5yr admin expense CAGR at conservative 10%.

CAR: No longer a major differentiating factor

BAFL’s CAR registered at 14.1% in 3QCY15 (vs. 11.5% in 3QCY14), supported by influx of

US$67mn investment by International Finance Corp. (IFC) last year. To recall, IFC

acquired a 15% equity stake in BAFL in 2014 (new shares issues @ PkR28/share), with an

option (expired in Dec’15 and not exercised) to purchase a further 5% stake. BAFL’s CAR

is now 3.8% higher than the minimum requirement for CY15. While BAFL may require

further capital to fund long-term Balance Sheet growth, we believe current capital levels

are sufficient to sustain both growth and dividends over the next 3-4yrs.

ROE converging to Big-5 levels

BAFL has seen its ROE converge to the Big-5 levels over the last few years. This is a

function of (i) ROE normalization for the Big-5 in part due to regulatory steps to curb

spreads and (ii) BAFL’s own turnaround on the back of much-improved asset quality (incl.

end to Warid impairment) and CASA uptick.

Asset quality has significantly improved…

0%

2%

4%

6%

8%

10%

12%

-

5,000

10,000

15,000

20,000

25,000

30,000

3Q

CY1

0

1Q

CY1

1

3Q

CY1

1

1Q

CY1

2

3Q

CY1

2

1Q

CY1

3

3Q

CY1

3

1Q

CY1

4

3Q

CY1

4

1Q

CY1

5

3Q

CY1

5

PkR mn

NPL Stock NPL Ratio (Rhs)


…which will limit medium-term credit costs

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

0%

20%

40%

60%

80%

100%

CY1

0

CY1

1

CY1

2

CY1

3

CY1

4

CY1

5F

Coverage Credit cost (Rhs)


CAR sufficient to fund medium-term growth…

12.06%

12.75%

13.35%

12.58%12.19%

12.40%

12.63% 10.0%

10.0%

10.3%

10.7%11.3%

11.9%

12.5%

CY13

CY14

CY15F

CY16FCY17F

CY18F

CY19F

CAR

Min CAR


…while also enabling consistent dividends

46%

47%

48%

49%

50%

51%

52%

-

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

CY15F CY16F CY17F CY18F CY19F

DPS Payout Ratio (Rhs)


6 | P a g e

Perspective

We believe Tier-I ROE in the high teens is the new normal for BAFL which compares

favorably to last 10yr ROE of 15%-16%. In spite of this, BAFL trades at a 50% discount to

the Big-5 on P/B (ex-NBP). With capital no longer an imminent concern and several

Balance Sheet metrics (e.g. CASA, Coverage) now resembling the Big-5, we believe BAFL

is strongly placed to witness a valuation catch-up.

ROE continues to converge to top-tier levels…

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

CY0

8

CY0

9

CY1

0

CY1

1

CY1

2

CY1

3

CY1

4

CY

15

F

CY

16

F

CY

17

F

CY

18

F

CY

19

FBAFL Big-5 Big-5 Ex. NBP


…meanwhile valuation discount is at unjustifiable level

0.0

1.0

2.0

3.0

4.0

Jan

-08

Jan

-09

Jan

-10

Jan

-11

Jan

-12

Jan

-13

Jan

-14

Jan

-15

Jan

-16

PBV (x)

BAFL Big-5 - ex NBP


7 | P a g e

Perspective

Plugged into the new business cycle

A new business cycle has commenced with greater credit offtake a likely corollary; LT

private sector loans growth has already accelerated to 20%YoY. With the Big-5 eyeing

big-ticket project finance (where BAFL will also be involved) but still too timid to

aggressively venture into lower strata, BAFL has an open field to further entrench its

strong positioning in the SME/Commercial and Retail segments. At the same time,

medium-term Islamic banking prospects remain exciting where we flag: (i) win-win for

Islamic financing of GoP projects (Sukuks) and (ii) potential dedicated Islamic banking

subsidiary ala MCB.

Credit cycle dynamics

Pickup in underlying business activity has started to reflect in systemic loan growth;

while trade finance/working capital are understandably subdued in conjunction with the

commodity bear run, LT fixed investment loans are growing at 20%YoY. There is

discernible pickup in SME loans (up 6.3%YoY) as well as Retail loans (especially auto

financing: up 35.1%YoY). As a result, once the commodity markets stabilize, the headline

loan growth number is expected to enter double-digits and accelerate thereon. In this

regard, our channel checks indicate systemic loan growth expectations of 12%YoY in

CY16F followed up by 15%-17%YoY in CY17-18F.

SME/Commercial financing: right place, right time

SME/Commercial exposure for BAFL is not new with this broader segment already

accounting for more than 20% of the bank’s loan book. Reducing credit costs over the

last 7-8yrs (from 150bps to 50bps) for BAFL indicates risks within this segment can be

managed even as, from a historical viewpoint, this has been a difficult sector (systemic

NPL ratio for SME: 31.6%). With larger banks still generally focused on the corporate

segment, BAFL’s aspirations in the high-yielding SME/Commercial segment (plans to

increase loan book share to 27% in the medium-term) can help shore up NIMs if the

interest rate environment remains subdued.

As per our talks with BAFL management, the bank intends to leverage its existing

corporate relationships by targeting smaller businesses associated with the vertical

supply chain of major companies. This would allow the bank to capitalize on the

untapped and growing demand for advances from smaller businesses, as the benefits of

the macroeconomic uptick (e.g. CPEC) trickle down.

Superior exposure in SME/comm paves way for further uptick…


SME financing has potential to surprise

7.6%

8.0%

8.4%

8.8%

9.2%

9.6%

-

50,000

100,000

150,000

200,000

250,000

300,000

Mar

-13

May

-13

Jul-

13

Sep

-13

No

v-1

3

Jan

'14

Mar

-14

May

-14

Jul-

14

Sep

-14

No

v-1

4

Jan

'15

Mar

-15

May

-15

Jul-

15

Sep

-15

No

v-1

5

PkR Mn

SME (Lhs) SME/Total Pvt. Credit

Source: SBP

8 | P a g e

Perspective

Retail is exciting too!

Growth in consumer finance has bottomed out, punctuated by a significant spike in auto

financing (up 35%YoY). However, systemic consumer finance accounts for just 8.5% of

total loans, still some way short of their 17% share in CY07; while household debt/GDP is

a paltry 2.7. Considering a soft interest rate environment is expected to persist, banks

should devote increasing attention to high-yielding and underpenetrated segment

where; after auto finance, unsecured products (personal loans/credit cards) have

immense growth potential. Presence of a centralized Credit Information Bureau (CIB) this

time around implies an implosion on the consumer side ala 2008 is unlikely, going

forward, in our view.

In BAFL’s case, the consumer segment accounts for 5% of its loan book vs. estimated 20%

of loans back in CY07 when BAFL was known as a “consumer bank”. Given BAFL

management is interested in SMEs, which has a higher inflection rate than Consumer

(10.4%), we see the bank increasing its retail exposure in a bid to shore up NIMs.

Banking sector’s credit to Consumers has bottomed out…

0.0%

4.0%

8.0%

12.0%

16.0%

20.0%

Jul-

06

Mar

-07

No

v-0

7

Jul-

08

Mar

-09

No

v-0

9

Jul-

10

Mar

-11

No

v-1

1

July

-12

Mar

-13

No

v-1

3

July

-14

Mar

-15

No

v-1

5

Consumer loan/Private sector loan


…where auto financing is leading the way

0

20,000

40,000

60,000

80,000

100,000

120,000

Jul-

06

Jan

-07

Jul-

07

Jan

-08

Jul-

08

Jan

-09

Jul-

09

Jan

-10

Jul-

10

Jan

-11

Jul-

11

Jan

-12

July

-12

Jan

-13

July

-13

Jan

-14

July

-14

Jan

-15

July

-15

PkR mn

Car Financing


SME/Commercial segment snapshot

• SMEDA defines SMEs as having (i) up to 250 employees, (ii) paid-up capital of

PkR25mn, (iii) annual sales up to PkR250mn. Within individual banks, the

SME/Commercial segments are often overlapping with no clear demarcation.

• SME sector in Pakistan has a 30% contribution to GDP and accounts for almost 80%

of the non-agriculture labor force. However, its share in private sector credit is less

than 10%, the gap plugged in by the informal sector, often at exorbitant interest

rates.

• SME NPLs account for almost 14% of systemic NPLs while the inflection ratio within

this segment is more than 30%. Poor asset quality, together with information

asymmetry which adds to costs for screening, processing etc. leads to banks

generally ignoring the SME/Commercial segment.

• SMEs are dominated by Trading and Manufacturing concerns, with the bulk of

borrowers availing working capital finance up to PkR3mn. With Pakistan requiring

7% GDP growth to absorb 1.7mn people entering the workforce each year, small

businesses are likely to mushroom, particularly as we expect urban sector growth to

outpace rural growth over the next few years.

9 | P a g e

Perspective

CPEC can drive corporate demand…

As stated earlier, LT fixed investment loans are currently one of the fastest loan growth

categories. This is a function of increasing industries entering an expansion phase:

• Officially announced cement sector expansions total 7.7mn tons which accounts for

17% of current installed cement capacity. This dovetails with pickup in construction

activities especially in the entertainment segment (e.g. malls).

• Consequent to the Auto Policy being formally announced, incumbents may opt for

expansion while new foreign OEMs may also enter. Allied industries e.g.

batteries/tires are already seeing expansions and new entrants.

• Sectors experiencing a slowdown e.g. Fertilizers are pursuing diversification

especially in the broader Food sector.

Some of the above are cognizant of CPEC-generated demand going forward. As

energy/infrastructure projects directly under the CPEC umbrella achieve financial close

(bulk likely to be financed by Chinese credit), ancillary credit demand should still result in

a trickle-down impact for local banks.

…and Islamic financing can be a good fit

BAFL has one of the largest Islamic banking networks in the country, with 157 local

Islamic banking branches and an asset base of PkR116bn (7.7% market share; 14.7%

share in BAFL’s book). Islamic contribution to BAFL’s total assets has reduced from 20%

in CY12 on (i) maturing high-cost term deposits and (ii) lack of asset-side products

particularly GoP-driven Sukuks. However, there are signs of change where:

• BAFL Islamic is participating in major projects such as the Sindh Engro Coal Mining

(SECMC) while some major projects like the Diamer Bhasha dam and Karachi-

Sukkur motorway will involve Islamic financing.

• The GoP has recently elongated its domestic borrowing duration with PIBs

(conventional banks) preferred over Sukuks due to lack of viable underlying assets.

With CPEC coming into play, this can change and be a win-win with new Sukuks

likely to yield less than PIBs (positive for GoP) but more than current pricing for

current Sukuks (KIBOR or lower; positive for Islamic banks).

• Other than the corporate side, the SBP believes that small businesses are more

inclined towards Islamic banking products due to religious factors. BAFL is one of

the few banks that has the potential to tie-in its SME and Islamic propositions.

• SBP push on Islamic banking is evident; the central bank has eased initial MCR for

Islamic banks to PkR6bn (vs. PkR10bn previously). Major banks such as MCB have

already set up a separate Islamic entity and BAFL can potentially follow suit

(separation of conventional/Islamic businesses at BAFL is at least a decade-old

aspiration).

Sukuks have the potential to catchup with PIBs touching saturation point

0%

6%

12%

18%

24%

30%

36%

Jun

-11

Au

g-1

1

Oct

-11

De

c-1

1

Feb

-12

Ap

r-1

2

Jun

-12

Au

g-1

2

Oct

-12

De

c-1

2

Feb

-13

Ap

r-1

3

Jun

-13

R

Au

g-1

3

Oct

-13

De

c-1

3

Feb

-14

Ap

r-1

4

Jun

-14

R

Au

g-1

4

Oct

-14

De

c-1

4

Feb

-15

Ap

r-1

5

Jun

-15

Au

g-1

5

Oct

-15

Contribution to GoP domestic debt

Sukuk contribution PIBs contribution


CPEC can catalyze credit demand where

LT loans are already growing at more

than 20%YoY

GoP demand for Sukuks can see higher

yields on the same

10 | P a g e

Perspective

The timing is right

BAFL missed out in the last macro bull cycle (CY03-CY07) due to being in expansion

mode and then faced a prolonged period of tough macros subsequently. It now enters

a higher-growth cycle having completed its newest round of branch expansion (649

branches; 75 of which were added after CY13 and are hitting profitability now). This

means BAFL’s profits should be able to withstand pressures from low interest rates/PIB

re-pricing where our CY16F/17F EPS projections are 7%/5% higher than consensus

estimates. positive earnings surprises can come into play via (i) one off gains from

Warid deal, (ii) capital gains on investments, and (iii) earlier than expected

materialization of cost efficiencies.

Ahead of the curve

BAFL’s total branches were last reported at 649 (up 7%YoY), in line with the bank’s plan

to take the network to 700 branches by 2017. In this regard, the branch network has

doubled from CY09 levels (321 branches) with 65 added in CY12, 103 in CY13 and 74 in

CY14.

We note the following:

• Bulk of BAFL’s branch additions took place in CY13/14, and the bank is not

planning to embark on another expansion phase.

• Considering branches typically take about 1.5yrs to become profitable, the

impact is becoming visible now with normalized pre-tax profit per branch at a

10yr high (PkR17.8mn/branch).

BAFL: per branch profits are accelerating

0%

5%

10%

15%

20%

25%

-5.0

0.0

5.0

10.0

15.0

20.0

CY0

8

CY0

9

CY1

0

CY1

1

CY1

2

CY1

3

CY1

4

9M

CY1

5

Growth in br. (Rhs) PBT Ex. CG/branch


…while others lag behind

0.0

5.0

10.0

15.0

20.0

25.0

CY11 CY12 CY13 CY14 9MCY15

PBT Ex. CG/Br. (PkRmn)

MEBL FABL BAHL


Room to realize scale efficiencies…

0

5

10

15

20

25

30

35

AB

L

MC

B

UB

L

MEB

L

BA

HL

HB

L

AK

BL

NB

P

BA

FL

HM

B

FAB

L

Admin Cost/Branch (PkRmn)


…as staff/branch comes off

0

4

8

12

16

20

HB

L

MC

B

AB

L

UB

L

NB

P

AK

BL

MEB

L

BA

HL

BA

FL

HM

B

FAB

LStaff/Branch


11 | P a g e

Perspective

• Several medium-sized banks are still in the midst of network expansion, while

BAFL is consolidating. Current staff/branch for BAFL at 18 is broadly at par with

medium-sized peers but is expected to continue converging towards the Big-5

average (10) going forward.

We believe BAFL now has the necessary platform via its branch network and balance

sheet size to start realizing scale economies. Per branch profitability is significantly up

and is headed for all-time highs (PkR20mn+). With medium-sized peers still growing

infrastructure and some larger banks held back by deceleration in international

operations, BAFL has the potential to outperform over our investment horizon.

Earnings estimates

BAFL posted record-high NPAT of PkR2.31bn (EPS: PkR1.45) in 3QCY15 vs. NPAT of

PkR1.46bn (fully-diluted EPS: PkR0.92) in 3QCY14, up by 58%YoY, with the bank not yet

touching its unrealized capital gains backlog. As a result, BAFL’s 9MCY15 NPAT clocked in

at PkR5.98bn (EPS: PkR3.76), up an impressive 50%YoY (pre-tax: up 67%YoY).

Going forward, we forecast EPS of PkR5.02/5.10/5.31 for CY15/16/17F where our

estimates are 5%-7% higher than consensus. Positive earnings surprises can occur on:

Mobilink-Warid merger

BAFL has an 8.76% stake (319mn) shares in Warid Telecom costing PkR4.3bn but written

down to zero following periodic impairment. We now understand that Vimpelcom/GTH

(sponsors of Mobilink Telecom) will acquire 100% of Warid in exchange for a 15% stake

in Mobilink. Details indicate a Mobilink-Warid merger will be sought in 6months, with

Dhabi Group to have a 15% stake in the merged entity. Assuming BAFL will be left with a

1.3% stake (8.76% * 15%) in Mobilink post-merger, we value this stake in the PkR0.5-

PkR1.0/share range (pre-tax) based on (i) last reported BVPS of Warid and (ii) EV/EBITDA

method. It is unclear if gains (if any) are routed through P&L (impairment reversal) or

directly added to equity.

Capital gains – PIBs & equities

BAFL realized capital gains of PkR1.4bn in 9MCY15, more than double that realized in

9MCY14 (PkR630mn). Even so, BAFL’s remaining pre-tax unrealized capital gains backlog

on AFS securities still stands at PkR10.6bn (13.4% of assets; 20.6% of equity). Our capital

gains projections for full-year CY15F/16F/17F stand at PkR2.07bn/PkR1.86/PkR1.77bn,

where higher than expected gains will result in positive earnings surprises.

Further upside from capital gains remains a possibility

0%

2%

4%

6%

8%

10%

12%

14%

16%

-

2,000

4,000

6,000

8,000

10,000

12,000

CY0

7A

CY0

8A

CY0

9A

CY1

0A

CY1

1A

CY1

2A

CY1

3A

CY1

4A

CY1

5F

CY1

6F

CY1

7F

CY1

8F

CY1

9F

Warid stake partly sold

PkR bn

NPAT CG/PPI (RHS)


Positive earnings surprises can occur on

(i) Mobilink-Warid merger, (ii) capital

gain realization, and (iii) earlier than

expected cost efficiencies

12 | P a g e

Perspective

Less susceptible to foreign sell-off

While the big-5 ex-NBP are facing the heat with consistent foreign sell off, BAFL has

managed to hold ground. Price performance suggests that BAFL has outperformed the

larger banks (FYTD: BAFL up 15.6% vs. Big-5 ex-NBP 12.5% down) on account of relatively

less foreign shareholders exposure (~6% ex. associate companies and sponsors). We

believe that lower susceptibility to foreign sell-off could allow BAFL to outperform peers

considering the prevalence of persistent negative foreign investors’ sentiment; the

banking sector (likely concentrated in the larger banks).

Valuation

BAFL currently trades at a CY16F P/B of 0.83x and P/E of 5.74x, where our Dec’16 TP of

PkR35.2/share offers an upside of 20.3% (Total return: 28.9%) from its last closing price

of PkR29.3/share. We have valued BAFL using a blend of justified P/B (50%), DDDM

(25%), DDM (15%), and justified P/E (10%). Given (i) asset mix shift in favor of advances

from zero weighted investment in government securities, and (ii) increase in CAR

requirement (from 10.25% in CY15F to 12.5% in CY19F), we highlight the growing

importance of CAR in the valuation equation by employing the Distributable Dividend

Discount Model (DDDM).

DDDM is a measure of the dividend paying potential of a bank to its shareholders (with a

condition of not more than 100% payout) as it calculates the present value of the

distributable dividends based on minimum capital adequacy requirement set forth by

the SBP. The terminal value is calculated using the justified P/B at terminal year and

sustainable growth rate.

DDDM Model CY15F CY16F CY17F CY18F CY19F

NPAT (PkRMn) 7,963 8,098 8,430 9,695 11,017

Projected Dividends 3,969 3,969 4,365 4,762 5,556

Unappropriated profit required 140 6,581 13,618 18,751 24,842

Add: Beginning unappropriated profit 9,613 12,833 15,367 18,167 21,582

Statutory reserve 1,593 1,620 1,686 1,939 2,203

Distributable Dividend 7,963 8,098 8,430 7,172 5,554

Payout ratio 100% 100% 100% 74% 50%

PV of distributable dividend 8,098 7,205 5,239 3,468

Terminal justified P/B 1.19

Terminal year equity value (PkR mn) 67,741

Est. Sustainable Growth Rate 9.3%

Est. Cost of Equity 17.0%

PV of terminal value 42,295

NPV of equity using DDDM 66,305

Number of shares (mn) 1,587

Fair value per share (PkR) 41.77


BAFL has outperformed peers FYTD…

-20%

-10%

0%

10%

20%

MCB NBP UBL ABL HBL BAFL


…backed by less exposure of foreign investors

21.32

(3.84)

(9.98)(15.47) (15.28)

(25.55)

0.07

(30)

(20)

(10)

-

10

20

30

Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 DEC-15 Jan-16

FIPI Flows in Banks (US$mn)


13 | P a g e

Perspective

Method (Dec'16) TP (PkR) Weight Weighted Avg TP

(PkR

P/B (CY16F) 32.91 50% 16.46

P/E (CY16F) 32.27 10% 3.23

DDM 33.79 15% 5.07

DDDM 41.77 25% 10.44

Blended TP 35.19

Target Price sensitivity to changes in base case PIB yields

35.2

6.1 1.9

27.2

2.1 2.3

39.6

-

5

10

15

20

25

30

35

40

45

Base 0.5% -se 1% -se Pessi

mistic

0.5% +se 1% +se Optimistic

Downsides

Upsides


14 | P a g e

Perspective

Risks

Economic risk

Though Pakistan seems to be on track to achieve a GDP growth above 5% over the

medium term, it still continues to face economic risks, including: (i) structural

inefficiencies, (ii) delays in addressing energy deficiency, (iii) bleak export performance,

and (iv) stressed fiscal deficit on account of low tax-to-GDP. Failure to address these

issues might have a detrimental impact on economic indicators and therefore on the

banking system.

Regulatory risk

We believe that the regulatory risks have been played out, with no further cut in DR and

move from SBP to trim spreads likely in the medium term. However, in the long run, we

flag possibility of an increase in MCR, which might lead to further consolidation in the

sector. Moreover, we believe that the medium and the smaller banks will be under

pressure to ensure CAR levels above the rising requirement under BASEL-III (12.5% by

CY19F vs. 10.25% in CY15). If BAFL misses our earnings estimates, it may have to cut

dividends and/or raise additional capital over the medium to long term.

Political risk

Political uncertainty has significantly eased off ever since PTI/TUQ sit-ins took place in

2014. However, concerns still prevail over sustainability of law and order situation in

Karachi, impact on foreign policy following US elections, and geopolitical development in

the region. Therefore, economic prospects in the medium term rely majorly on the

successful completion of current PML-N government’s term.

Reinvestment risk

BAFL, though with the second lowest IDR, has the second highest exposure in PIBs, thus

making its earnings more susceptible to reinvestment risk. That said, we believe

sufficient capital gains backlog can mitigate this risk to some extent in the medium term.

BAFL- 2nd highest PIBs exposure despite 2nd lowest IDR

BAFL

ABL

NBP

UBL

MCB

HBL

40%

50%

60%

70%

80%

90%

20% 30% 40% 50% 60% 70%

IDR

PIBs/Investment Source: IMS Research

15 | P a g e

Perspective

BAFL – Financial Snapshot

CY14A CY15F CY16F CY17F CY18F

Mark-up earned 55,378 60,574 63,425 71,566 81,527

Mark-up expensed 33,505 32,202 34,047 39,643 44,712

Net Mark-up 21,873 28,372 29,378 31,923 36,815

Total Provisions 1,534 1,518 1,734 2,221 3,062

Net mark-up after provision 20,340 26,854 27,644 29,702 33,754

Fee, comm. and brokerage income 3,120 4,430 4,984 5,607 6,252

Dividend income 492 554 609 670 720

Income from dealing in FX 2,043 1,655 1,820 1,957 2,104

Capital gains 1,218 2,071 1,864 1,771 1,505

Other income 2,163 735 791 850 914

Total non mark-up income 9,036 9,446 10,068 10,855 11,495

Total Income 29,376 36,299 37,712 40,557 45,248

Administrative expenses 20,261 22,065 24,248 26,516 29,188

NPBT 8,514 13,512 12,715 13,264 15,254

NPAT 5,641 7,963 8,098 8,430 9,695

CY14A CY15F CY16F CY17F CY18F

Cash and balances 50,516 54,306 62,248 70,392 80,974

Balances with other banks 12,332 10,459 12,342 13,797 15,964

Lending to fin. institutions 18,313 37,480 31,329 26,062 20,526

Investments 324,319 400,945 434,331 442,025 487,486

Advances 290,597 319,657 358,016 417,088 476,523

Other Assets 31,311 32,686 31,803 32,194 34,780

Fixed Assets 15,740 16,997 18,038 18,396 19,385

Total Assets 743,128 872,530 948,106 1,019,954 1,135,638

Bills payable 11,758 12,699 13,651 14,675 15,776

Borrowings from fin. institutions 55,233 124,274 105,633 73,943 70,246

Deposits and Other Accounts 605,963 654,192 745,879 847,235 954,877

Sub-ordinated loans 9,987 10,000 8,333 5,000 10,000

Other Liabilities 14,515 15,966 17,164 18,451 19,835

Deferred Liabilities 853 1,920 1,440 1,080 810

Total Liabilities 698,309 819,051 892,100 960,384 1,071,543

Net Assets 44,819 53,478 56,006 59,570 64,095

Share Capital 15,872 15,872 15,872 15,872 15,872

Reserves 12,338 13,931 15,550 17,236 19,175

Unappropriated Profits 9,613 12,833 15,367 18,167 21,582

Sub Total 37,824 42,636 46,790 51,276 56,630

Non Controlling Interest 37,824 42,636 46,790 51,276 56,630

Surplus on Revaluation of assets 6,995 10,843 9,216 8,295 7,465

Total Equity 44,819 53,478 56,006 59,570 64,095

Key Ratios CY14A CY15F CY16F CY17F CY18F

EPS (PkR) 3.55 5.02 5.10 5.31 6.11

P/B Tier I (x) 1.23 1.09 0.99 0.91 0.82

BVS (PkR) 28.23 33.69 35.28 37.53 40.38

P/B (x) 1.04 0.87 0.83 0.78 0.73

PER (x) 8.25 5.84 5.74 5.52 4.80

Tier I to Assets 5.1% 4.9% 4.9% 5.0% 5.0%

Loan to Deposit 48.0% 48.9% 48.0% 49.2% 49.9%

NIMs 4.2% 4.2% 3.8% 3.9% 4.1%

Loan growth 11.4% 10.0% 12.0% 16.5% 14.3%

Deposit growth 15.3% 8.0% 14.0% 13.6% 12.7%

Cost/Income 67.5% 60.3% 63.4% 63.8% 62.1%

ROE (Tier-I) 17.1% 19.8% 18.1% 17.2% 18.0%

DPS (PkR) 2.00 2.50 2.50 2.75 3.00

Dividend yield 6.8% 8.5% 8.5% 9.4% 10.2%

Payout Ratio 56.3% 51.0% 51.0% 48.0% 48.0%

BAFL Forward P/E Band – (x)

0

10

20

30

40

50Ja

n-0

7

Oct

-08

Au

g-1

0

May

-12

Ma

r-1

4

Jan

-16

(PkR) (x)10.0

8.0

6.0

4.0


BAFL P/B Band – (x)

0

10

20

30

40

50

60

Jan

-07

Oct

-08

Au

g-1

0

May

-12

Mar

-14

Jan

-16

(PkR) (x)

1.5

1.2

0.9

0.6


16 | P a g e

Perspective

I, Abdul Ghani Fatani, certify that the views expressed in the report reflect my personal views about the subject

securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the

specific recommendations made in this report. I further certify that I do not have any beneficial holding of the

specific securities that I have recommendations on in this report.

Ratings Guide

Buy Upside more than 20%

Accumulate Upside more than 10% but less than or equal to 20%

Neutral Upside from 0% to 10%; Downside from 0% to -10%

Reduce Downside more than 10% but less than or equal to 20%

Sell Downside more than 20%

Disclaimer: Intermarket Securities Limited has produced this report for private circulation only. The information, opinions

and estimates herein are not direct at, or intended for distribution to or use by, any person or entity in any jurisdiction where

doing so would be contrary to law or regulation or which would subject Intermarket Securities Limited to any additional

registration or licensing requirement within such jurisdiction. The information and statistical data herein have been obtained

from sources we believe to be reliable where such information has not been independently verified and we make no

representation or warranty as to its accuracy, completeness and correctness. This report makes use of forward looking

statements that are based on assumptions made and information currently available to us and those are subject to certain risks

and uncertainties that could cause the actual results to differ materially. No part of the compensation of the author(s) of this

report is related to the specific recommendations or views contained in this report.

This report is not a solicitation or any offer to buy or sell any of the securities mentioned herein. It is meant for information

purposes only and does not take into account the particular investment objectives, financial situation or needs of individual

recipients. Before acting on any information in this report, you should consider whether it is suitable for your particular

circumstances and, if appropriate, see professional advice. Neither Intermarket Securities Limited nor any of its affiliates or any

other person associated with the company directly or indirectly accepts any liability whatsoever for any direct or consequential

loss arising from any use of this report or the information contained herein.

Subject to any applicable law and regulations, Intermarket Securities Limited, its affiliates or group companies or individuals

connected with Intermarket Securities Limited directly or indirectly may have used the information contained herein before

publication and may have positions in, or may from time to time purchase or sell or have a material interest in any of the

securities mentioned or may currently or in future have or have had a relationship with, or may provide investment banking,

capital markets and/or other services to, the entities mentioned herein, their advisors and/or any other connected parties.

This document is being distributed in the United States solely to “major institutional investors” as defined in Rule 15a-6 of the

US Securities Exchange Act of 1934, and may not be furnished to any other person in the United States. Each US person that

receives this report by its acceptance thereof represents and agrees that it: is a “major institutional investor” as so defined, and

understands the whole document.

Investors should contact their Intermarket Securities representative if they have questions concerning this report.

IMS Coverage Initiation-Bank Alfalah Limited 13-01...

Documents

Transcript of IMS Coverage Initiation-Bank Alfalah Limited 13-01...