We rate OCBC Buy/Low Risk, with a target price of S$8 (from S$6.50). 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 tend to lead an STI recovery as valuations normalize from trough levels, P/E multiples expanding in anticipation of earnings recovery. OCBC is typically viewed as the least operationally leveraged of its peers to economic recovery and rising interest rates, and conversely it has greater earnings resilience in a less favourable outlook and falling short-term rates, in part due to its capital strength and diversified earnings.
Our target price for OCBC is S$8. (1) Using a dividend discount model (DDM), assuming a 2009E net DPS of S$0.28, cost of equity of 9.8%, and a long term growth rate of 6.3%, gives a fair-value P/E of 15.8x 2009E, which when applied to our 2009E EPS of S$0.51 derives a fair value of S$8, which equates to a 2009E P/B of 1.6x (vs. 10.7% ROAE). We use DDM as a primary valuation tool, as we view it reflects sustainable earnings, dividend growth and excess returns relative to cost of equity, and also factors in liquidity/sentiment impact on valuations. It is also consistent with the methodology underpinning our P/E investment cycle analysis framework. (2) Using our P/E cycle analysis, which suggests an average trough-peak P/E range for the Singapore banks of 11-18x (for OCBC 12.4-17.6x, average 15.0x) on one-year forward consensus estimates, our target price P/E is above the cycle mean for OCBC.
We rate OCBC Low Risk to reflect the capital strength and financial regulation of the Singapore bank sector. This is in-line with our quantitative risk-rating system, which tracks 260-day historical share price volatility. Possible downside and upside risks to our target price include: 1) the extent of impact of the US/global economy on Singapore's domestic economy and job growth; 2) the level of short term interest rates and shape of the yield curve (generally lower S$ SIBOR is at the margin positive for OCBC, and conversely); 3) changes to the (currently benign) asset quality position and in turn provision charges; 4) market liquidity risk appetite; and 5) dividend policy and capital mgmt. These risks could impede the stock from achieving our target price.
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