Weekend Comment Apr 29: DBS surprises on the upside

Stock Name: DBS
Company Name: DBS GROUP HOLDINGS LTD
Research House: CIMB

“I COULDN’T HAVE asked for a better set of results,” Piyush Gupta, CEO of DBS Group Holdings, tells journalists at the 1Q11 results’ media briefing on April 29, “And before anyone asks, we are not in discussion for any inorganic deal in Indonesia or anywhere else,” he reiterates. For the January-March period, DBS posted a record net profit of $807 million against $532 million a year earlier, representing a 52% y-o-y rise.

Net profit came in significantly above the average of analysts’ expectations of $685 million, beating even the high end forecast of $720 million. Gupta, who took over in November 2009, says the results reflect the execution of his nine-point strategy. Capital ratios remained strong. Tier-1 CAR was 14.2% (4Q: 15.1%) and core Tier-1, 11.5% (4Q: 11.8%). 1Q11 ROE rose to 12.1% from 10.2% in 4Q10. Cost-to-income ratio was maintained at 40%.

Additionally, DBS Hong Kong appears to have turned the corner, reporting a net profit of $190 million, up 6% y-o-y and 32% q-o-q, despite the HKD weakening by 3% against the SGD.

However, Gupta cautions against extrapolating the $807 million net profit figure for the remaining three quarters this year. He warns of headwinds going forward, including debt problems in the European Union, slower than expected growth in the US, inflationary pressures in Asia, and Central Banks tightening across Asia. “The bigger risk is the cooling off, and a hard landing in China will have serious implications,” he says. “There is no clarity on any of these yet.” Against this background, Gupta expects loan growth for this year to be in the low double-digits, driven by demand in the region.

In 1Q, loans grew 4% during the quarter to $157.5 billion, led by corporate borrowing in Singapore, Hong Kong, India and China. Because of the challenging low SIBOR, net interest income rose a mere 1% q-o-q to $1.12 billion. Gupta doesn’t expect an uptick in interest rates till the end of the year as the Federal Reserve has indicated that interest rates are unlikely to rise in view of tepid economic growth. However, he reckons that net interest margins (NIMs), which rose 1bp q-o-q to 1.8% in 1Q, could have seen their lows.

One of the reasons for maintaining NIMs this year is diversifying geographic spread, with the bank seeing loan growth in India and China, Gupta says. “NIM contribution from India and China are rising and this has made an impact on the group level.”

Harsh Modi, analyst at JP Morgan, thinks that the 1bp rise in NIMs is significant. “We believe this marks an inflection point and is a change in trend for DBS margins. This trend change will be first time in a decade that DBS NIMs move up without rates rise,” Modi writes in a report dated Apr 29. Also, he points out that DBS strategy of “asset duration lengthening” and a move up on LDR (loan to deposit ratio) is now showing up in NIMs. “The drag of back-book re-pricing has been offset by higher duration. This was the key data-point investors were looking for in our view, and the stock should rally from here,” Modi states.

However, the real driver for net profit gains appears to be the 26% q-o-q gain in non-interest income. Fee income rose 16% q-o-q to $416 million. IPOs during the quarter, including the mega US$5.5 billion ($6.7 billion) Hutchison Port Holdings Trust listing, and the Road King Infrastructure’s RMB1.3 billion ($246 million) bond issue boosted investment banking. In Hong Kong, DBS garnered RMB18 billion in deposits, and was joint bookrunner for Singamas’ RMB1.4 billion bond issue.

“Fee income surprised positively, though this may be inflated by strong investment banking fees especially with DBS’s involvement in the Hutchison Port Trust IPO in 1Q11,” notes Goldman Sachs in an update on Apr 29. “Fee income growth was pretty broad based, with trade/remittances/loans, and wealth management fees growing, reflecting DBS’s strategic initiatives to expand these businesses. A larger surprise was treasury income, which contrary to the Street’s doubts for DBS to sustain its high treasury gains, as seen in 1Q10, did very well, reflecting DBS’s push on treasury cross-sell,” the Goldman report states.

“Growth in the loan book is on the institutional side,” Gupta points out. Looking forward, he expects loan growth to be led by the corporate side and in the region. But DBS is unlikely to experience much mortgage growth in Singapore and Hong Kong, he adds. “Mortgage demand around the region in slowing off as every Central Bank tries to slow down the property market,” he says. Last year, loan growth came from corporates refinancing. This year, regional corporates are borrowing for investment, Gupta says. In terms of IPOs, DBS has a healthy pipeline but nothing as big as the Hutchison Port deal. “We have a small role in Glencore’s IPO of US$11-12 billion in a co-lead role,” he says.

CIMB is forecasting a net profit of $2.75 billion for DBS this year, up 68% y-o-y, and a price target of $17.00 which represents a price to book of 1.4 times the book value of $11.61. The stock last traded at $14.98.