Looking g ood value with concerns removed
We reinstate coverage with a Buy rating and a target price of HK$40 giving a total shareholder return of 31%. Since the global financial crisis in 2008 DSF (along with DSB) has been de-rated th e most among HK banks, with P/B falling to as low as 0.4x owing to massive losses in investments. Since then there has been significant transformation, making the bank much safer than before in our view. This report marks the transfer of coverage from Tracy Yu to Franco Lam.
A safer investment book
Since 2008, DSF has de-rated the most compared with other HK banks owing to investment losses amounting to HKD1.7bn (10% FY12 equity). In our view, DSF has de-risked its portfolio and been proactive in selling down higher risk assets. The higher risk bond exposure has now decreased 61% from its peak, with the gap between carrying and fair value the smallest since 2008, suggesting further surprises in provisions are unlikely.
Return to traditional banking business.
The bank went back to its basic traditional banking in which lending accounted for 59% of FY12 assets (vs 53% during the financial cr isis period). We believe this deployment of assets will be a safe r approach for DSB as the bank can be more reactive to the deterioration in le nding portfolio given its closer proximity to lending customers.
Valuation discount to peers, we expect rerating to continue
The stock has underperformed HSI by 2% YTD. We expect the bank’s now safer investment book and refocus on traditional banking business to lead to a recovery in profitability and reach a tipping point for stock outperformance. We value DSF using the Gordon Growth Model (P/B=ROE-g/COE-g). We assume an average ROE of 7%, a cost of equity of 9.7% and a long-term growth rate of 2.5%. This provides us with an average target P/B ratio of 0.6x.
Applying this to DSF’s average FY2013-14E book value, we derive our 12-month target price of HKD40. Key downside risks: 1) weakness in capital markets; 2) a severe deterioration in the export market; 3) an asset quality issue in Chongqing; and 4) a reversal in liquidity inflow and higher funding costs.