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Morningstar | Standard Chartered FVE Increased to HKD 74, or GBX 740; Value Emerging

We take a fresh perspective on Standard Chartered, and we believe the bank’s massive upheaval is starting to bear fruit with improved profitability. Higher-than-expected operating expense in the first half was a slight disappointment, but this was offset by acceleration in operating income growth. Our fair value estimate increases slightly to HKD 74 from HKD 71, or GBX 740 from GBX 700, as we factor in the time value of money, offset by slightly lower forecasts. A decline in the bank’s share price, along with the rest of the market, provides an opportunity to enter the stock.

Our no-moat rating on the bank is unchanged. While we forecast return on equity to steadily increase over our five-year explicit forecast period, we do not expect return on equity to reach management guidance of 8% and our cost of equity assumption of 10% in the five-year forecast period. Our cost of capital assumption includes a 1% country-risk premium, proportionate to the bank’s geographic operation. We revise our moat trend rating to stable from negative, as we do not expect a significant deterioration in the bank’s cost position. At the group level, operating expense is expected to increase as the bank invests for growth, while maintaining support services, particularly in compliance, to avoid its previous money-laundering debacles from occurring again. This is matched with rising operating income, and we forecast the bank’s cost/income ratio declining to 66% at the end of our explicit forecast period from the current level of close to 70%.

We also revise our uncertainty rating on the bank to high from very high, as risk has eased, in our view. Idiosyncratic risk from its earlier Iranian deals remains, as a deferred prosecution agreement with U.S. authorities was extended to the end of this year. However, the bank has strengthened its compliance controls in recent years. For the banking industry, we do not expect regulatory risk to increase from here as the implementation of Basel III gradually completes over the next two years. From a capital perspective, the bank’s financial health is on a more solid footing. The common equity Tier 1 ratio improved to 14.2% in first-half fiscal 2018 from 13.6% in 2017.