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Al Rajhi Bank: Cost of funding advantage set to underpin further dividend growth; BofA Merrill Lynch.

Upgrading to Buy as earnings momentum set to accelerate

BofA Merrill Lynch is upgrading Al Rajhi to Buy from Neutral, with a PO of SAR 75/share. BofA Merrill Lynch sees Al Rajhi's earnings momentum gathering pace in 2H17 given: (1) Stand out NIM expansion on the back of a unique cost of funding position (90 per cent of funding comes from low cost, retail biased demand deposits) and further policy rate hikes; and (2) A less severe deterioration in asset quality than BofA Merrill Lynch previously expected. The shares currently trade on 12mth FWD P/B of 1.8x a 24 per cent discount to historical levels despite its competitively advantaged positon, healthy growth and strong returns (20 per cent mid-cycle RoTE).

Raising estimates on stronger NIMs and asset quality

BofA Merrill Lynch raises its 2017-19 EPS estimates 11 per cent and its PO to SAR75/share on the back of: (1) Stronger volume growth as we expect Al Rajhi to benefit from the underpenetrated KSA consumer banking market (2) Higher NIMs as BofA Merrill Lynch lowers its cost of funding estimates (3) Lower cost of risk as asset quality deterioration less acute than expected; and (4) Higher ROEs on stronger earnings and a sustained increase in dividend pay-outs.

Excess capital generation to underpin higher pay outs

With an improved earnings outlook, BofA Merrill Lynch now sees scope and capacity for further dividend growth in the medium term. Indeed, Al Rajhi increased its 1H17 dividend to SAR1.5/share (vs. SAR0.75 in 1H16), equating to a c. 60 per cent pay-out ratio. Were Al Rajhi to maintain a 60 per cent pay-out, wBofA Merrill Lynch estimates tier-1 ratios would reach 17.4 per cent by 2021 from 21 per cent currently, comfortably above regulatory requirements.

Index inclusion a potentially potent catalyst

Following Saudi's recent addition to MSCI's watch list for inclusion in the EM index, BofA Merrill Lynch sees improved probability for a reclassification by June 2019. Should this be the case, Al Rajhi could potentially attract $1.8 billion of inflows, accounting for 35 days of average flow. Before that, an announcement by FTSE of a potential Saudi inclusion in its EM index in the September 2017 review could provide another catalyst for the shares.

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Publication:CPI Financial
Date:Aug 17, 2017
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