We rate UOB Buy/Low Risk, with a target price of S$16.50 (from S$14). We are positive on all of the Singapore banks given our view that the Singapore economy is passing its point of worst contraction, and our strategist expects the Singapore STI could recover to the 2400 level. Past market cycles suggest that banks will tend to lead an STI recovery as valuations normalize from trough levels, P/E multiples expanding in anticipation of earnings recovery. UOB is best known as an SME lender and hence exposed to a slowdown in this segment of the economy. UOB also has the largest holding of equity AFS securities, giving concern over book value erosion in a falling market, but equally could be beneficial in a market recovery.
Our target for UOB is S$16.5. (1) Using a dividend discount model (DDM), assuming a 2009E net DPS of S$0.60, and cost of equity of 10.7% and 7.1% long-term growth rate, gives a fair-value P/E of 14.1x 2009E, which when applied to our 2009E EPS of S$1.17 derives a fair value of S$16.5, which equates to a 2009E P/B of 1.6x (vs. 12.9% ROAE). We use DDM as a primary valuation tool, as we view it reflects sustainable earnings, dividend growth and excess returns relative to cost of equity, and also factors in liquidity/sentiment impact on valuations. It is also consistent with the methodology underpinning our P/E investment cycle analysis framework. (2) Using our P/E cycle analysis, which suggests an average trough-peak P/E range for the Singapore banks of 11-18x (for UOB 10.8-15.2x, average 13.0x) on one-year forward consensus estimates, our target price P/E is above the cycle mean for UOB.
We rate UOB Low Risk, to reflect the capital strength and financial regulation of the Singapore bank sector. This is in-line with our quantitative risk-rating system, which tracks 260-day historical volatility of shares. Possible downside and upside risks to our target price include: 1) the extent of impact of the US/global economy on Singapore's domestic economy and job growth; 2) the level of short term interest rates and shape of the yield curve; 3) changes to the (currently benign) asset quality position of the bank and in turn provision charges; 4) market liquidity/ investor risk appetite; 5) the outlook for Thailand and pace of recovery of UOB's Thai operations; and 6) capital management. These risks could impede the stock from achieving our target price.
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Banking stocks are the worst performing stocks and all because of them overall stock markets are headed downwards.
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