UOB is Singapore's third-largest bank by group assets (S$181bn as of Sept 2008). Its primary business focus is Singapore (70% of group pre-tax profit) and Malaysia (11% of group profit). In recent years the bank has made significant investments in both Thailand and Indonesia. UOB is primarily an SME and consumer-focused bank.

We are negative on all the Singapore banks given our bearish view on the Singapore economy. We have a Sell / Low Risk (3L) rating on UOB shares, with a target price of S$10.50, in line with our Singapore strategy view that the Singapore STI will head to the 1,500 level. UOB has been a beneficiary of Singapore's 2006/07 mid-affluent private residential property recovery. The recent collapse in residential property sentiment has led to a slowdown in mortgage growth later in the year. UOB as an SME lender would also be exposed to a slowdown in that segment of the economy, suggesting that provisions are set to rise.

Our target for UOB is S$10.50. (1) Using a dividend discount model (DDM), assuming a 2009E net DPS of S$0.60, and cost of equity of 11% and 5.1% long-term growth rate, gives a fair-value P/E of 9.1x 2009E, which when applied to our 2009E EPS of S$1.15 derives a fair value of S$10.50, which equates to a 2009E P/B of 0.92x (vs. 10.2% 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 UOB 10.8-15.2x, average 13.0x) on one-year forward consensus estimates, our target price PER of 9.1x is below the range trough for UOB, reflecting recession bear market trough multiples.

We rate UOB shares 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 volatility of shares. Potential upside (and downside) 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; 3) changes to the (currently benign) asset quality position of the bank and in turn provision charges; 4) market liquidity/ investor risk appetite; 5) the outlook for Thailand and pace of recovery of UOB's Thai operations; and 6) capital management. These risks could cause the stock to deviate from our target price.