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Meezan Bank (MEBL): Best Positioned to Leverage Growing Shariah Banking; Initiating coverage with a 'Buy'

• Investment Thesis: We initiate coverage on Meezan Bank (MEBL), Pakistan’s largest Shariah Bank, with a ‘Buy’ call and target price of Rs123 offering 38% upside. MEBL is expected to outperform peers based on 1) strong brand recognition and market leadership in islamic banking fueling robust deposit growth, 2) expanding Net Interest Margins (NIMs) and rapid Current Account (CA) growth, 3) biggest beneficiary of rising interest rates among peers, 4) faster credit growth and one of the lowest NPLs to loans ratio and 5) improving cost efficiency.
• Strong brand fueling deposit growth: The Bank has managed to establish a unique brand for itself and is distinguished as the pioneer and leader in developing Islamic Banking industry of Pakistan. MEBL’s strong brand recognition as a Shariah compliant bank with strong infrastructure will keep growth trajectory intact, in our view. The Bank is expected to deliver robust 5-Year (2018-22) deposits CAGR of 17% aided by growing awareness of Islamic Banking as well as continued branch expansion. This is in comparison to our forecasted  banking sector deposits CAGR of 13%.
• Expanding NIMs and high CA growth: NIMs of the Bank will expand to ~3.9% in 2022 compared to 3.3% during 2017, as we expect CA to grow at 5-Year (2018-22) CAGR of 19% along with anticipated increase in interest rates. Resultantly, Net Interest Income (NII) of the bank will grow at a 5-Year (2018-22) CAGR of 21% compared to previous 5-Year (2013-17) CAGR of 15%.
• Major beneficiary of rising rates: MEBL has one of the highest proportion of Rate Sensitive Assets (RSA) as Advances (above average ADR of 62%) are floating while more than 70% of its investments in Sukuk certificates/bonds (IDR 18%) do not have a re-pricing risk as they are linked with Kibor (or average 6M T-bill rate). Combined with low sensitivity of MEBL’s deposits to interest rates (no minimum deposit rate requirement for Islamic Banks), we believe that MEBL will gain the most due to rising interest rates.
• Relatively faster credit growth and one of the lowest NPLs to Loans ratio: MEBL is also expected to deliver strong credit growth compared to its peers, wherein, we expect 5-Year (2018-22) advances CAGR at 15% compared to Topline Banking Universe advances CAGR of 13%. This is because MEBL has increased its penetration and is growing its foothold in consumer and SME segments. Further, MEBL’s asset quality is one of the best amongst its peers due to prudent lending practices. Its NPLs to loans ratio stands at 1.5% while its coverage ratio is at 134% compared to banking sector average of ~8% and ~92% respectively. Notably, the bank is one amongst two Pakistani listed banks to have NPLs to Loans ratio of below 2% and coverage ratio of more than 100%. 
• Improving cost efficiency: MEBL is expected to reduce its cost to income ratio to average 51% for the period 2018-22 compared to average of 59% for the period 2013-17. We attribute decline in expenses growth to slower pace of branch expansion. Moreover, rapid branch expansion (291 added in five years 2013-17) in previous years will contribute significantly to the bottom-line going forward. Similarly, investments in ADC should add to profitability as well, along with higher interest rates.
• Valuation: We have a ‘Buy’ stance on MEBL with a target price of Rs123/share. The value of MEBL is based on Sum Of The Parts (SOTP) method where we value MEBL (unconsolidated) at Rs119/share and MEBL’s share in its asset management company, Al-Meezan Investment Management, at Rs4/share. MEBL is trading at 2019E PE and PBV of 9.1x and 2.2x with ROE of 26%. It offers the highest expected return (38%) in Topline Banking Universe and is cheaper than most of the other Topline Universe Banks on the basis of 2022F ROE (adjusted for PBV). We believe, MEBL will also witness the phase where it will trade at high PE & PBV multiples just the way MCB traded at an average PBV/PE of 2.7x/9.8x with average ROE of 20%+ during 2001-15 (high growth period).
• Key Risks: Key risks for the bank include 1) lack of shariah compliant investment avenues, 2) lower than expected uptick in interest rates, 3) faster uptick in NPLs due to economic slow down and 4) growth slowdown due to CAR concerns.