After the central bank’s surprise U-turn on policy rate in a short span of three months, the next question which arises in investors’ mind is the change in earnings of listed companies, especially banks.
“Banking stocks that have been marred during the last few years due to low interest rates scenario are expected to yield the most out of this move,” said Topline analyst Zeshaan Afzal.
The recent policy shift will not only widen banking spreads due to high return on earning assets but also the impact on profitability will be further magnified this time due to the recent imposition of minimum deposit rate as it has squeezed margins in last few quarters.
At present, one of the most important assumptions in the financial models of banks is the quantum of further increase in interest rate.
The analyst said he had revised his discount rate projection for 2014 and onwards on the back of their slightly upward revised inflation target of 9.5-10.5 percent in FY14 (Previous 9-10 percent in FY14) and SBP hint on further monetary tightening. “Keeping minimum deposit rate constant at 6 percent on average balances, we have assumed another 100bps increase in discount rate in 2014. Incorporating all, we have revised up our sample banks 2013-2015 earnings by an average 7 percent.” Though banks were always sensitive to movement in interest rates, recent scenario of relatively low banking spreads had increased their sensitivity to the change, he added.
“Due to low interest rates and relatively higher deposit costs (in the shape of 6 percent minimum rate), banking spreads have shrunk to 7-year low,” said the analyst.
During 1H2013, banking spreads have average at 6.25 percent which are lowest since 1H2005. Keeping all other factors constant a 50bps increase in interest rate results in likely to increase spreads by 30bps. With the assumption of another 100bps increase in 2014 along with the improvement in balance sheet, earnings of the Topline’s banking universe are expected to rise by 21 percent during 2014 compared to 4 percent decline in 2013.
Though the interest rate outlook suggest significant rise in future earnings, the analyst maintained ‘market-weight’ stance on local banks on the back of recent price performance in the banking stocks.
“Our banking sample is currently trading at 2013E PE and PBV of 10.4 and 1.8x respectively with average ROE of 17.6 percent,” Afzal said.
Going forward, with expected earnings growth of 21 percent in 2014, the sector trades at PE of 8.7x and PBV of 1.7x on 2014 projections with estimated average ROE of 19.3 percent.
