EUR 16.26 For Business Accounts Only

United Bank (UBL): Earnings revised downwards; 'Buy' Stance maintained

• We revise down our earnings estimate for UBL by 13%/10%/11% for 2018/19/20 to Rs19/28/33 per share after incorporating 1Q2018 financial results however we maintain our ‘Buy’ stance on the stock. Our earnings revision is triggered mainly on account of higher than expected pension cost and concerns on international operations leading to higher provisioning charge.
• The bank booked a one-off pension cost of Rs6.4bn (Rs3.4/share) in 1Q2018 which was higher than our assumption of Rs4.7bn for the year. The management in its 1Q2018 report stated that this number is based on the actuarial estimate of the cost of pension payable. The estimate may change based on the ongoing verification process.
• The bank booked a provisioning charge of Rs2bn in 1Q2018 which is well above quarterly average. Risk of Non Performing Loans (NPLs) against international operations remain a key risk for UBL as NPLs during 1Q2018 stood at Rs27bn which is (now 50% of their total NPLs) and are up 10% QoQ. 
• We believe that slowdown in GCC economies and subjective classification against international NPLs by the bank has led to this uptick and provisioning charge on its international operations. International advances contributed around 25% (33% in 1Q2017) in bank’s total advances in 1Q2018 with main concentration in UAE. The bank has been trying to curtail its international advances on the wake of key risks faced by the bank on its international operations.
• It is to be noted that the coverage of the international advances currently stands at 68% which is well below its coverage of 90% for its domestic operations. We expect bank’s coverage ratio on international operations to gradually improve going forward. The management in 1Q2018 conference call stated that although coverage on international operations will improve however the quantum of the provisioning charge could be lower compared to 1Q2018. Every 5% increase in coverage impact UBL’s bottom-line by Rs0.7/share (3% of earnings).
• On a positive note, consolidated NPL ratio of UBL declined to 7.7% in 1Q2018 vs. 8.1% in 1Q2017 led by recoveries from domestic operations. We anticipate it to remain at these levels going forward as Pakistan macros continue to improve and bank is focusing on making significant recoveries on domestic front. 
• Earnings of the bank excluding one-off pension cost & provisioning charge stood at Rs6.8/share in 1Q2018 as compared to Rs6.1/share in the same period last year. This was driven by strong performance on domestic front by the bank.
• UBL posted deposit growth of 10% YoY whereas CASA deposits of the bank was up 18% showing improving deposit profile of the bank. Consequently, CASA ratio of UBL improved to 76% in 1Q2018 vs. 71% in 1Q2017. This was mainly triggered by domestic CASA which improved from 83% in Mar 2017 to 87% in Mar 2018.
• UBL domestic advances grew by 40% whereas international advances were trimmed by 4%. On consolidated basis, net advances grew by 27%. Going forward we expect advances to grow ~15% annually in 2018-20 mainly led by domestic advances.
• Non-interest income of UBL also improved by 17% due to higher capital gains during 1Q2017. Fee, commission & brokerage income posted growth of 21% led by higher remittance business, trade commission, card business and banc assurance.
• CAR of the bank has improved from 15.5% in Dec 2017 to 16% in Mar 2018 which is well above the SBP minimum capital requirement of 11.9% for 2018. The bank as per its announcement dated Feb 19, 2018 also plans to raise Additional Tier 1 Capital of up to Rs10bn (inclusive of green shoe option) which will further improve the overall CAR of the bank.
• We also anticipate SBP to gradually raise the policy rate from the current 6% to 8.75% by 2020 due to expected up tick in inflation which bodes well for UBL’s NIMs which are expected to cross 4% by 2020.
• The stock currently trades at a 2019 PE and PBV of 7.2x and 1.2x with ROE of 22%. The stock has also come down 8% from its recent peak seen on Jan 10, 2018. Our target price of Rs236/share offers an upside of 18% and the stock offers dividend yield of 6%.  
• Key risks for the bank includes 1) lower than expected hike in interest rates, 2) lower than advances & deposit growth, and 3) increased NPLs/provisions on international operations.