KimEng Bank Mandiri: An attractive valuation, BUY

Growing bigger efficiently
Bank Mandiri’s deposit franchise is the biggest in the sector, accounting for 14.5% of total third party funds at commercial banks. The excess liquidity will act as a strong base for Mandiri’s estimated loan growth of 15.6% in 2009 and 20.0% in 2010F. In 1Q09, Mandiri managed to outperform BRI in terms of total credit. The bank’s huge business scale translates into high operating efficiency, at 42.3% Cost-to-Income Ratio by 1Q09, down from 48.8% in 1Q08. But this is not without room for further improvement on the long term. The overall characteristics create an appealing combination seldom found in the banking sector.

Targeting a better balance in asset
After a recent cut in mortgage rate, the bank signaled an intention to reduce its entire lending rate to accommodate growth in loan demand. As of 1Q09, mortgage remained the bigger portion of Mandiri’s total consumer lending. The overall figure has gradually climbed by 25% YoY to Rp19.7t in 1Q09. While new loans are expected to generate lower yields, Mandiri will be one of the beneficiaries of the upward trend in credit cycle. The bank plans to expand its high-yield retail lending base. Hence, we expect Net Interest Margin to increase after 2011F on better asset and deposit mix, and enhanced loan quality which will consequently reduce the amount of Non Performing Loan.

Eyes on the lower NPL
Mandiri’s current 6.5% gross NPL ratio makes us more comfortable on the bank’s risk management over its bad loan legacy. Although the ratio is still high compared to industry average of 3.9%, we have seen a significant reduction from 16.4% NPL by end of 2006. Nevertheless, we like to keep an eye on the write-offs and restructured loans details as often that NPL ratio underestimates the level of bad loans. Recent new NPL formation suggests that NPL to rise to 7.5% by 2011F. However the rate should be lower afterwards as the economy improves.

Alternative investment with high ROE
With the above mitigating factors, we recommend BUY on Bank Mandiri at TP Rp3,900/share, implying a 22.8% upside potential from current price. Based on our target price, Mandiri will be trading at 2010F PBV of 2.1x and PER of 12.1x. Our target price is based on PBV valuation, with ROE forecast of 19.0%, above the 15.5% cost of capital. At this sustainable ROE rate, and 2010F PBV of 1.7x on current price, we find Mandiri’s valuation attractive compared to its peers (banking stocks are trading at an average 2.3x PBV)

Risks
The main risk to our target price and earnings estimates is a surge in inflation, which will affect interest rates, loan demand, and asset quality. Bank Mandiri is also exposed to decreasing yields from its bond portfolio, as it consists mostly of those with variable rates. Another issue to watch for is the bank’s NPL ratio as it shows a new NPL formation despite its ability to gradually reduce the bad loan legacy.