Merrill Lynch has initiated coverage of Israel Discount Bank (TASE: DSCT) and Mizrahi Tefahot Bank (TASE:MZTF). The investment bank gives Discount Bank a “Buy” recommendation with a target price of NIS 11, a 30% upside compared with its current price of NIS 8.55. It gives Mizrahi Tefahot Bank a “Neutral” rating, but set no target price.
Merrill Lynch says that Discount Bank has huge upside potential in every area of activity, after 15 years of management inertia. Discount Bank “could easily add NIS 500 million to net earnings by 2009”, an increase of 50%. “We think the bank has the best earnings growth outlook in the sector, driven by an increased contribution from retail, business services activation and a refocusing of Israel Discount Bank of New York.”
Merrill Lynch adds, “Even compared to the inexpensive Israeli banking sector, Discount Bank comes out cheap… On our estimates, with compound growth in book value of 11% over the next four years, the valuation is even more attractive.”
Merrill Lynch cautions, however, “While we are positive on earnings delivery, Discount Bank’s main weakness is its cost base, which is above that of its peers. As with all turnaround stories, execution is key. Cost-cutting is central to Discount Bank’s ability to increase profitability.”
Merrill Lynch predicts that Discount Bank will post a net profit of NIS 1.36 billion in 2007 and NIS 1.07 billion in 2008. It predicts that the bank’s earnings per share (EPS) will be NIS 0.68 in 2007, up nearly five-fold on 2006, and that EPS will rise a further 24.6% to NIS 0.85 in 2008.
As for Mizrahi Tefahot Bank, Merrill Lynch says it that “management has positioned Mizrahi Tefahot as one of the highest quality banks in Israel.” However, Merrill Lynch dislikes the fact that “in principle, it is still a mortgage bank”, and its “sizable exposure to the low-margin mortgage portfolio highlight the lack of ability to achieve notable higher sustainable return on equity.”
Merrill Lynch says, “We believe Mizrahi Tefahot Bank’s strategy should work fine in principle but less so in reality. We as yet have found little evidence that the bank has managed to leverage its mortgage clientele base into cross selling and better access for retail banking activity. Moreover, denser competition in retail lending plus a higher loan-to-deposit ratio will make it challenging to buff up performance, leaving the banks more sensitive to the razor-thin mortgage margins.”
Mizrahi Tefahot Bank is not expensive, but it trades at a premium compared with Bank Hapoalim (LSE: BKHD; TASE: POLI) and Discount Bank, and at the same level as Bank Leumi (TASE: LUMI). Merrill Lynch concludes, “Incorporating the higher execution risk that Mizrahi Tefahot Bank should warrant, we believe upside is better had elsewhere.”
Merrill Lynch predicts that Mizrahi Tefahot Bank will post a net profit of NIS 902 million in 2007 and NIS 723 million in 2008. EPS is predicted to total NIS 3.10 in 2007, up 244% on 2006, and rise another 4.8% to NIS 3.25 in 2008.
Published by Globes [online], Israel business news - www.globes.co.il - on September 19, 2007
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