Standard Chartered(2888.hk):Rocking and roiling

Challenging outlook. Reiterate SELL.

Standard Chartered’s share price has fallen 30% since the bank’s 1H15results (YTD: -31%). The operating environment has becoming morechallenging in recent weeks and legacy issues may be more of aconstraint than we previously anticipated. We cut our 16-17CL EPS by 13-40%. A capital raise remains likely. We reiterate our SELLrecommendation with a revised target price of HK$65 (GBP5.50).

Operating conditions continue to worsen

By our calculations, 76% of the bank’s loan book is in Asia and 38% is inemerging markets. In recent weeks we have been trimming estimates for asignificant proportion of banks under coverage in Asia due to lower top lineand higher bad debt expectations as operating conditions become morechallenging. StanChart is negatively impacted in two ways: i) lower earningsgrowth ii) an inability to dispose of non-core assets at an attractive valuationLegacy issues could be more of a headwindWe had pencilled in US$300m of litigation/settlement costs into our 16CL EPSfigure and acknowledged that the situation could more severe. Whether it isbigger fines or operational constraints the net result is lower earnings. Inaddition, our earlier estimate of US$865m in restructuring and investmentcosts may also prove too low if the fixing of the bank is more aggressive.

We revise 16-17CL EPS down by 13-40%

A more challenging operating environment, legacy issues, the UK bankingsystem stress test, risk aversion, restructuring and a larger share count arelikely to lead to lower earnings between 2H15CL-17CL than previouslyanticipated. We cut our 15-17CL EPS by 13-40%. We leave our 15-17CL DPSstable at US$0.43 given the sizeable re-basing in 1H15.

Reiterate SELL with revised cum-rights HK$65TP (previously HK$104)

StanChart is trading 29% below its historical trough p/BV but i) its ROE hasnever been this low for a prolonged period ii) this is a material reshaping ofthe group amidst unsupportive and deteriorating operating conditions iii) thecapital debate is not over. We believe a US$3bn capital raise is likely. Wevalue Standard Chartered using the adapted Gordon Growth Model which isbased on an ROE of 7.7%, a COE of 11.6% and a terminal growth rate of 4%for a target PB multiple of 0.5x. Our valuation is equivalent to valuing thebank with 6% ROE (towards the top end of our ROE forecast through 17CL)against 11.6% COE with no growth.