Bank Alfalah (BAFL) post CY14 results and incorporate the impact of 2% reduction in the key policy rate since November 2014. We believe heavy investments in PIBs will bolster the company’s bottomline in CY15. Overall, we expect the bank to deliver 4-yr earnings CAGR of 9.3% (CY14-18E) over our investment horizon. We maintain our Outperform rating on BAFL as its previous aggressive branch expansion positions it well to benefit from an economic recovery, and tweak our TP down slightly to Rs34.22 from Rs34.23.
- Investment in PIBs dilutes the impact of constrained margins: In line with the industry, the bank increased its exposure in PIBs (~57% of investments in CY15 vs 15% in CY14), taking the Investment to Deposit Ratio (IDR) to 54%. With ~30% of deposits placed in PIBs at higher coupon/interest rates, we believe the monetary easing cycle will rather play to BAFL’s benefit (PLS rates linked to floor of Interest Rate Corridor). Hence, we see NIMs sustaining at 3.7% in CY15 vs 3.8% in CY14 and push bottomline growth by ~14%.
- Beyond CY15, we expect a 3-yr earnings CAGR of 7.9% over CY15-18E as the bank shifts its investment portfolio to lending portfolio. However, we factored in a conservative approach given borderline CAR of 12.8%.
- Branch expansion to play favorably: Previously the bank had adopted an aggressive expansion strategy, increasing the overall number of branches from 386 in 2010 to 648 in CY14. This has allowed the bank to enjoy deposit growth of ~14% over the last 4 years. In the mid-tier category, its increased reach makes it well-placed to capture the incremental deposit flow associated with envisioned economic recovery.
- Cost-to-income ratio may improve: Administrative expense continued to be a drag on earnings, as reflected in the higher cost-to-income ratio of ~66% in CY14 (owing to branch expansion). We believe the bank’s initiative to improve operating efficiency would reduce the cost-to-income ratio going forward. Further conviction to our call may come from aggressive development on branchless banking (introduced in CY14).
Earnings and target price revision
- We cut our CY15-17E earnings estimates by 16-18%, incorporating: 1) CY14 results; and 2) recent monetary easing. We adjust our risk-free rate assumption and roll forward our valuation to Dec 2015.
- 12-month price target: Rs34.22 based on a DCF methodology.
- Catalyst: Uptick in private credit offtake and sale of Warid
Action and recommendation:
- We remain positive on BAFL in the mid-tier category due to better NIMs. At CY15E P/B of 0.8x and D/Y of 7.8%, we maintain our Outperform rating.