By G. Sharmila
Hong Leong Bank Bhd’s upcoming mutual separation scheme and a rights issue have received mixed reviews from analysts, especially after the bank’s recent lower-than-expected first quarter results for FY16. Should investors tread a little more carefully where this stock is concerned?
Business model: According to its website, Hong Leong Bank (HLB) was incorporated in 1905 in Kuching, Sarawak under the name of Kwong Lee Mortgage and Remittance Co and later in 1934, incorporated as Kwong Lee Bank Ltd.
In 1989, it was renamed MUI Bank and five years later, the group acquired MUI Bank through Hong Leong Credit Bhd (now known as Hong Leong Financial Group Bhd). This milestone saw the birth of HLB and in October the same year, the bank was listed on the Kuala Lumpur Stock Exchange (now Bursa Malaysia).
In 2004, the finance company business of Hong Leong Finance Bhd was acquired by HLB. In 2011, HLB completed the merger with EON Bank Group.
Today, HLB has a network of over 300 branches, sales and business centres in Malaysia, Singapore, Hong Kong, Vietnam and Cambodia. In 2008, HLB was the first Malaysian bank to enter the Chinese banking sector with a 20% strategic shareholding in Bank of Chengdu Co, Ltd.
In December that year, HLB became the first and only Malaysian and Southeast Asian bank to be granted a licence to incorporate and operate a 100% wholly-owned commercial bank in Vietnam. In 2013, HLB launched its 100% wholly-owned commercial bank in Cambodia. The bank also has a representative office in Nanjing.
Shareholders and management: Most associated with HLB is its somewhat iconic chairman, 72-year-old Quek Leng Chan, who is a barrister by training. According to the bank’s 2015 annual report, he has extensive business experience in various business sectors, including financial services, manufacturing and real estate.
He was appointed to the bank’s board of directors in January 1994 and is also chairman and chief executive officer (CEO) of Hong Leong Co (Malaysia) Bhd, chairman of Hong Leong Financial Group Bhd, Hong Leong Capital Bhd, GuocoLand (Malaysia) Bhd, Hong Leong Assurance Bhd and the Hong Leong Foundation.
Close behind is the bank’s 58-year-old group managing director and CEO Tan Kong Khoon, who is a Singaporean. Tan was appointed to his position in July 2013. He has a Bachelor of Business Administration degree from Bishop’s University, Canada and is an alumnus of the Harvard Business School Advanced Management Programme.
Tan was formerly the group executive, consumer banking group of DBS Bank Ltd from 2010 to 2013, where he led and managed strategy formulation and execution for consumer banking globally across the DBS Group.
He began his career with DBS in 1981 and since then had successfully built consumer banking franchises across multiple markets in Asia for Citibank, Standard Chartered Bank and ANZ Bank. He was also formerly president and CEO of Bank of Ayudhya, the fifth-largest bank in Thailand listed on the Thailand Stock Exchange.
Share performance: According to data from Bloomberg, HLB’s share price return over the past year has been about -2.98%, with a 52-week trading range of between RM11.89 and RM14.32. Compare that with the FBM KLCI’s one-year return of -4.4% and it’s clear that HLB shares haven’t done too badly.
Reuters data show that the stock has a beta coefficient of 0.92, which means trading in it is less volatile than market average (a beta of 1 and above indicates higher than average trading volatility). HLB also has a dividend yield of 2.98%, which could be viewed as attractive by investors new to the stock.
What analysts think: Some analysts tracked by KINIBIZ expressed caution over HLB’s prospects, given its rights issue and upcoming mutual separation scheme (MSS), while others expressed optimism.
MIDF Research and UOB Kay Hian Research were among the critics of the bank. In a report dated Nov 18, MIDF downgraded HLB from “buy” to “neutral”, citing the bank’s share price resulting in a total return of less than 15% as the reason.
“Despite our ‘neutral’ rating, we continue to see that HLB’s rights issue price of RM10.40 on an entitlement basis of four rights shares for every 25 HLB shares as attractive for existing investors to subscribe. This is looking at the potential upside to our target price as well as an opportunity to lower the cost of investment for HLB shares,” the research house said.
UOB Kay Hian was a lot harsher on the stock, downgrading it to a “sell” in a Nov 18 report, after factoring in HLB’s downward earnings revision and dilution from the rights issue. It also cut its target price to RM12 versus current theoretical ex-rights price of RM13.30. Post-rights, the research house expects HLB’s return on equity to drop to 10% from 11.5%.
The research house also said HLB has unexciting prospects even with cost savings from the MSS. “We expect financial year 2016 (FY16) earnings outlook to remain sluggish (-6.6% year-on-year) in spite of having incorporated two quarters of potential cost savings from its staff MSS.
Persistent nett interest margin (NIM) pressure, contraction in contribution from Bank of Chengdu and a sharp upward reversal in nett credit cost from a very low base (nett recovery in FY15) will drive downward pressure on FY16 earnings.
“Coupled with an expected 14% return on equity dilution from the group’s impending rights Issue, this will pose an immediate drag on share price performance as we believe the market may have yet to fully price in the above negative earnings and dilution impact,” it said. It also reduced its nett profit forecasts by 5% after incorporating a sharper compression in NIM and weaker contribution from Bank of Chengdu.
Maybank IB Research, which maintained its “buy” call on HLB, is a little more optimistic. It said it continues to be encouraged by the group’s strong fundamentals and liquid balance sheet. The research house also believes that upside surprise to FY17 earnings could result from the MSS.
“Assuming a 10% acceptance rate and a similar structure to its FY12 voluntary separation scheme, HLB’s MSS could cost about RM90 million, with savings of about RM78 million per annum,” it said.
Affin Hwang Capital, who also maintained its “buy” rating on HLB, said that despite concerns of weaker growth from China, it believes HLB’s earnings sustainability will be underpinned by its domestic operations as well as in Singapore, as the group leverages on new financing solutions such as healthcare-financing in Singapore and Malaysia (aiming to grow its portfolio to RM1 billion by 2018), digital banking with consumers and small and medium enterprises, and targets higher bancassurance fees from wealth management activities.
Earnings forecast:
StockStalk: We like that HLB has strong fundamentals and a healthy balance sheet, as pointed out by Maybank. Dividend yield could be more attractive, the current level may put off new investors in the stock.
On the bright side, potential savings from the bank’s MSS, new financing solutions in Singapore and Malaysia and higher bancassurance fees could augur well for the bank, giving hope to prospective as well as existing investors. We tend to that this established bank knows what it is doing and don’t think that the doom and gloom in China will persist, hence disagree with what UOB Kay Hian said.
All in all, we would say this is an interesting stock to look at, mainly for its growth potential. Although it is not cheap, now might be a good time to go in and hold on to the stock, while waiting to see how its rights issue and MSS scheme pan out.
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Important Note and Disclaimer: This article should NOT be taken as a cue to either buy or sell the stock. The intention is to highlight the key factors you might want to think about before plunging in or scrambling out. While KINIBIZ makes every endeavour to ensure facts are right and opinion is fair, no liability can be assumed for anyone relying on this information. In other words let the buyer (or seller) beware — a reflection of Bursa Malaysia, we say.
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