UOB (CIMB)

UNDERPERFORM Maintained
S$19.38 @02/06/11
Target: S$20.38

Indonesian growth strategy

Visit to UOB Indonesia. We visited UOB’s Indonesian operations earlier in the week and came away with the impression that UOB is ready to be more aggressive after spending the last two years setting the foundation right. UOB is ready to focus on certain market segments and push for above-industry growth. UOB Indonesia’s targets are: 1) mid- and high-end consumers; 2) business banking or mini-SME banking; 3) fee income from commercial banking; and 4) leveraging its regional franchise to break into corporate banking. Given a limited size, we believe this is a sensible approach. But with Indonesia only accounting for 5% of group profits, managing margin pressures would be the bigger challenge for UOB for now and remains the basis for our Underperform rating as well as expected de-rating catalysts. Risks to our negative view are further evidence that efforts to derive feebased income bear fruit. Our target price of S$20.38, based on 1.5x CY11 P/BV (GGM-based, ROE 11.1% COE 8.9% growth 4.5%) is unchanged.

• Ready to grow in identified segments. UOB Indonesia has a 30% CAGR target for its earnings for 2011-15. In our opinion, in an environment where loan growth is 20-25% and margins are contracting, achieving this would require sustained market-share gains and a successful push into the fee business. That is possible but would demand various initiatives.

Ready to grow in identified segments. We visited UOB’s Indonesian operations earlier in the week. We came away with the impression that UOB had spent the last two years setting the foundation right and a refreshed management team is ready to focus on certain market segments and push for above-industry growth. UOB Indonesia’s targets are: 1) mid- and high-end consumers; 2) business banking or miniSME banking; 3) fee income from commercial banking; and 4) leveraging its regional franchise to break into the corporate banking market. Its vision is to be a premier bank in Indonesia, with a 30% earnings CAGR target for 2011-15. Negatives working against this are: 1) Indonesia currently accounts for only 5% of group pretax profits, thus successes here might not be meaningful for the group; and 2) margin pressures in the past year have not gone away and there remain near-term headwinds.

Background of UOB Indonesia. UOB operates in Indonesia mainly through PT Bank Buana. UOB started by acquiring a 23% stake in PT Bank Buana in 2004, eventually increasing its ownership to almost 100% in 2008, delisting Bank Buana and merging it with UOB Indonesia operations. The entity is known as UOB Indonesia today. Bank Buana was founded by eight shareholders and was mainly a small SME bank. It was a conservative outfit that went through the Asian crisis unscathed. UOB Group spent the last 2-3 years re-staffing the bank and integrating technology platforms and porting over the best practises and products from Singapore. Today, UOBI is headed by Mr. Armand Bachtiar Arief (President Director since 2007). Mr. Arief was previously part of the management team of PT Bank Internasional Indonesia. UOB has Rp38.3tr assets, gross loans of Rp27.45tr and deposits of Rp28.26tr. By assets, it is ranked the 16th largest in Indonesia (OCBC NISP 14th; DBS 19th) but by profits, it is ranked 12th(OCBC NISP 18th; DBS 20th). Market share is sub-2%.

Growing in commercial banking... The four segments under business lending are: 1) corporate banking; 2) commercial banking; 3) business banking; and 4) microbanking, in order of the size of clients’ businesses. UOB is not interested in microbanking as it is wary of the credit risks involved. Business banking was originally Bank Buana’s bread-and-butter. UOB still sees this as its main growth platform, though expansion in other segments has brought down business banking’s share of the loan portfolio to 31%. Lending spreads in business banking are attractive, credit risks are more manageable and there is still a large addressable market. This is where it hopes to concentrate its efforts. In commercial banking and corporate banking, margins are harder to eke out but banking relationships should provide opportunities to generate fee income in compensation. In these segments, the bigger local banks and foreign bulge-bracket big boys are formidable competitors. In commercial banking, UOB’s smaller branch network will put it at a disadvantage when it competes on pricing, hence the logical strategy of focusing on service and transaction convenience. In corporate banking, it is avoiding the mega-deal space and targets second-tier corporate-banking deals to start banking relationships with clients. Across the spectrum, competition is rife. Management guides that lending spreads have shrunk by about 100bp in the last 12 months.

… and in consumer banking. The consumer-banking business was non-existent at PT Bank Buana and to us, the three changes in recent years have been: 1) UOB is porting over its successful credit-card business in Singapore; 2) UOB is trying to start privilege banking to target mid- to high-end consumers; and 3) local management has convinced HQ of the merits of getting into the Indonesian mortgage market and UOB Indonesia will now offer mortgages. Our impression of the Indonesian mortgage market is that banks take on a lot of risk with property-developer customers. However, barring a macro shock like the Asian crisis, credit risks should be manageable as developers aim to protect their reputations and are unlikely to default. Like UOB’s strategy in Malaysia, credit risk management seems to hinge largely on due diligence in choosing property-developer partners and choosing choice development sites for financing. The segments that UOB is not interested in are motorcycle financing and mass-market credit cards. Its broad strategy in consumer banking is to snuggle into a niche space between a local bank and a foreign bank. UOB wants to leverage its 213 branches/sub-branches fully, but is conscious of branch productivity. It will not aim to have widespread branches to compete with the likes of BCA and BRI.

Synergies with UOB Group. UOB Indonesia has the largest branch network in the UOB family of subsidiaries. This enables the UOB Group to access the huge Indonesian market. Synergies for the group could include: 1) harnessing the group’s merchant offerings in Singapore and expanding the credit-card business in Indonesia; 2) harnessing more sophisticated products in Singapore and selling them to affluent clients in Indonesia; and 3) harnessing the branch network in the region and using it to make cross-border corporate loans and land DCM/ECM deals.

Valuation and recommendation

Maintain Underperform and target price of S$20.38, based on 1.5x CY11 P/BV (GGM-based, ROE 11.1% COE 8.9% growth 4.5%). Management has been extolling the virtues of a large ASEAN network and our visit to UOB Indonesia convinces us that it has been using its time to understand the Indonesian market and make the right staffing decisions. Management now seems more prepared to accelerate growth in Indonesia, with a 30% CAGR target for earnings. ROEs of 14.5% seem inferior to our forecasts of 21%-25% for the big banks in Indonesia though the lower profitability appears to be both a function of UOB Indonesia’s selective approach (in order to avoid credit problems in the future) and its inability to compete on funding costs or partake in the high-margin micro-lending segments. We think this is a sensible approach.

In our opinion, a 30% growth target in an environment where loan growth is 20-25% and margins are contracting would require sustained market-share gains and/or a successful push in the fee business from cross-selling and nurturing the high-end consumer segment. That is possible but whether success here would alter the investment case drastically for UOB is another thing. At 5% of group profits, Indonesia can help eventually but meanwhile, managing margin pressures remains the group’s biggest challenge. This remains the basis for our Underperform rating and de-rating catalysts expected. Risks to our negative view are further evidence that efforts to derive fee-based income bear fruit.