Hong Leong Bank

Hong Leong Bank (HLBK MK): A Solid Investment with Strategic Exposure to China

Overview:

Hong Leong Bank (HLBK), one of Malaysia’s top banking institutions, continues to stand out for its diversified banking services, strong domestic presence, and strategic international investments. A key element in the bank’s long-term success is its significant stake in the Bank of Chengdu (BOCD), a regional Chinese bank. Despite global headwinds, Hong Leong Bank has maintained resilient performance and strong fundamentals.

Recommendation and Target Price:

• Recommendation: BUY
• Target Price: MYR24.30
• Current Price: MYR21.10
• Potential Upside: +18%
• Broker: Maybank Investment Bank Berhad
• Date of Recommendation: September 9, 2024

Key Investment Highlights:

1. BOCD Investment: A Profitable Long-Term Bet

Hong Leong Bank’s investment in Bank of Chengdu (BOCD) has been a cornerstone of its growth strategy in China. Since acquiring a 19.8% stake in BOCD in 2008, this investment has yielded exceptional returns. The current value of HLBK’s stake in BOCD is estimated at MYR6.2 billion, against the original investment cost of MYR2.1 billion.

• Contribution to Group Earnings: BOCD has become a major driver of HLBK’s earnings, contributing about 31% of the group’s total earnings in FY24. This marks a sharp increase from its 18% contribution in FY19.
• Potential Stake Reduction: HLBK is considering scaling back its stake in BOCD to around 15% in the long term, reflecting a strategic move to prioritize growth from its domestic operations while still benefiting from BOCD’s solid performance.

2. BOCD’s Strong Fundamentals

BOCD’s performance has been impressive, with its fundamentals reflecting sound financial management:

• Cost/Income Ratio (CIR): BOCD’s CIR stood at an efficient 23.8% in 1H24, significantly better than HLBK’s 40.5% for FY24.
• Loan-to-Deposit Ratio (LDR): BOCD’s LDR of 84.2% indicates a well-balanced and liquid balance sheet (compared to HLBK’s 87%).
• Asset Quality: BOCD’s asset quality remains excellent, with a gross impaired loans (GIL) ratio of only 0.66% (vs HLBK’s 0.53%). BOCD has a high loan loss coverage (LLC) ratio of 496% compared to HLBK’s 155%.
• Return on Equity (ROE): BOCD posted a robust ROE of 18% in 1H24, far outperforming HLBK’s 11.8% during the same period.

3. Growing Domestic Operations

Despite the success of its Chinese investment, HLBK’s management recognizes the need to strengthen its core domestic operations. The bank aims to achieve this by:

• Driving Earnings Growth: Through higher net interest margins (NIMs), fee-based income (especially in wealth management), and improved cost efficiencies, HLBK aims to boost its domestic earnings contribution.
• Singapore Operations: HLBK is also targeting higher earnings growth from its Singapore operations, which have performed steadily.
• Digitalization and Automation: The bank is investing heavily in automation and digital solutions to reduce costs and improve operational efficiency.

4. Dividend Yield and Capital Strength

• Dividend Yield: HLBK’s dividend yield is currently 3.7%, which lags behind the 5% offered by its domestic peers. However, its dividend payout ratio (DPR) is expected to increase to 40% over time, potentially boosting yields to 3.9%.
• Capital Adequacy: HLBK’s CET1 ratio stands at 13.3%, a solid figure that ensures the bank is well-capitalized. Excluding its associate investments, this figure would be a much higher 18.9%, reflecting the strength of its core capital position.

5. Strong Loan Growth and NIM Stabilization

• Loan Growth: BOCD achieved 23% YoY loan growth as of end-June 2023, driven by infrastructure-related loans and government-owned enterprise (GOE) lending.
• Net Interest Margins (NIMs): HLBK’s NIMs have been under pressure due to interest rate cuts, dropping to 1.66% in 1H24. However, management expects NIMs to stabilize in the coming quarters, provided no further rate cuts are imposed.

Financial Performance and Projections:

Hong Leong Bank has demonstrated solid financial growth over the years, and its outlook remains strong.

Key Financial Metrics (FY23-FY27E):

• Core Net Profit: MYR4.2 billion in FY24A, projected to grow to MYR5.1 billion by FY27E.
• Operating Income: MYR5.77 billion in FY24A, expected to reach MYR7.05 billion by FY27E.
• Pre-Provision Profit: MYR3.43 billion in FY24A, projected to grow to MYR4.25 billion by FY27E.
• Core EPS Growth: Expected to rise from MYR2.05 in FY24A to MYR2.50 by FY27E.
• Dividend Yield: Rising from 3.5% in FY24A to 4.1% by FY27E.
• ROAE: Stable at 11.8% in FY24A, with slight decreases projected to 11.4% by FY27E.

Risks to Consider:

• Economic Slowdown: Any slowdown in Malaysia’s domestic economy could impact HLBK’s earnings growth.
• China Risks: Given HLBK’s substantial exposure to BOCD, any adverse developments in China’s economic or political environment, particularly in Sichuan Province where Chengdu is located, could negatively impact HLBK’s earnings.
• Interest Rate Pressure: Further reductions in interest rates could compress margins and affect profitability.

Conclusion:

Hong Leong Bank offers a compelling investment case, driven by its profitable stake in Bank of Chengdu and its strategic focus on strengthening its domestic operations. The bank’s strong financial performance, combined with prudent management and a favorable macroeconomic backdrop, positions it well for sustained growth. With an attractive target price of MYR24.30, the stock offers an 18% upside potential, making it a solid buy for investors seeking exposure to the banking sector in Malaysia and China.

This detailed report on Hong Leong Bank showcases its solid fundamentals, strategic investments, and growth prospects, offering investors a clear picture of why this stock remains a strong buy.

Thank you