Surge in liquidity reduces risk of investment securities holdings
We are upgrading DSFH to Buy, in tandem with upgrading its bankingsubsidiary DSBG to Buy, as we believe their valuation at a steep discount tobook value is unwarranted, given improving liquidity, which should delay thenormalization of credit costs by a couple of years, and stabilize its fundingcosts. Furthermore, a better credit outlook means risks surrounding itsinvestment security exposure to banks (34% of DSFH 1H12 book value) isdeclining. Our new target price increases by 38% to HK$36.90. Buy.
QE3 and continued capital inflow into Hong Kong positive for banking business
Our upgrade to Buy is driven by the improving outlook for DSFH’s bankingbusiness via its subsidiary DSBG, which accounts for 67% of DSFH’s totalvaluation. In our report “Hong Kong banks: Capital inflows & HKMAintervention net positive for small banks” dated 8 November 2012, we study theimpact of QE1 and QE2, and conclude that continued capital inflow shoulddelay the normalization of credit costs by a couple of years, and shouldstabilize funding costs. This should be most positive for DSFH compared to itspeers, as it is more dependent on higher-cost time deposits (75% of totaldeposits), and has larger exposure to smaller SMEs.
Investment securities exposure looks less risky helped by liquidity surge
Both DSBG and DSFH have been trading at close to half the book value sinceSept 2011, which we attribute to market concern over its investmentsecurities. Particularly worrying was its exposure to banks and financialinstitutions, which accounted for 65% of 1H12 book value, excluding HTMsecurities. This included HK$5.4bn of investments in banks and corporates(34% of book value) which were overdue for more than a year. The surge inliquidity and a better outlook on the EU debt issue, means the riskiness of suchexposure is decreasing, no longer warranting a significant discount on them.
Upgrading to Buy with target P/Bx of 0.7x; target price lifted 38% to HK$36.90
We use an SOTP valuation for DSFH. For the banking business, we use aGordon Growth Model to obtain a target price-to-book ratio. For the insurancebusiness, we use embedded value methodology, applying 1x EV and 2x theFY13E new business value. We apply a holding company discount of 20% toarrive at our target price, which we have raised to HK$36.90. Downside risks:weakness in capital markets, which would negatively affect insurance salesand insurance investment yields.