Wednesday, May 02, 2018 01.35PM / ARM Research
In this note, we update our earnings estimates and roll forward our target prices (FVE) for Guaranty Trust Bank (GTB) and Zenith Bank (Zenith).
We think 2018 will be a turning point for the Tier 1 banks. ROE growth is likely to have topped in 2017, and we now factor in a slower growth over the next few years. In the face of lower interest rate environment, cautious loan growth, and capital preservation, we think benign funding cost, asset quality improvement, lower provisioning, and resilience in non-interest revenue (NIR) will be central to earnings over 2018. Also, in a low-growth revenue environment and faced with digital disruption, cost discipline and efficiency improvements will be key drivers of earnings growth and profitability, longer term, for the banks, in our view.
For GTB and ZENITH, we expect a 200bps average decline in Capital Adequacy Ratio (CAR) due to IFRS implementation. While the banks have guided to a ~10% average loan growth in 2018, we think the reality will still tilt to the very quality names and thus limit potential for loan growth. Consequently, net loan book is expected to expand by average of 3% YoY, with a large part of this reflecting exposure to the $2.3 billion Project Falcon. Though we see improvement in asset quality, we see the scale of moderation lower than earlier expected, as the banks will likely reclassify some specific loans and make specific loan loss provision on some assets.
That said, much of the support to earnings will come from materially lower loan loss provision (avg. -32% YoY). Although NIR will be lower YoY, due to materially lower FX revaluation gains, we see some resilience on the trading and fee income leg. NIMs will be largely flat despite collective decline in asset yields, as funding cost will track lower YoY with some expansion in CASA deposit expected. Balance sheet is likely to remain liquid with expansion in investment securities book expected to support interest income (in absolute terms).
Irrespective, key risk to our assumption are:
i. steeper moderation in yields than expected;
ii. higher than expected loan growth;
iii. materially lower income on the fee and trading lines;
iv. larger than expected impact of IFRS 9; and
v. translation of FCY at NAFEX (currently: NIFEX).
Table 1: Valuation Summary
We revise our stance on Zenith to ‘STRONG BUY’ from ‘OVERWEIGHT’ earlier, following share price decline and having revisited our investment case after FY 17 and Q1 18 results. We expect the Bank’s earnings to expand 2% YoY to N5.78/share for FY 18 due to: i) substantial compression in funding cost (-92bps YoY to 4.3%) as the decline in yields allows the bank to rollover term-deposit at lower rates; and ii) improving asset quality with NPL ratio expected to moderate 50bps YoY to 4.2%.
Also, we expect Cost of Risk (CoR) to decline 118bps YoY to 3.5% implying loan loss provision of N74 billion (-25% YoY from N98 billion in FY 17). However, we estimate a 14% YoY decline in non-interest revenue (NIR), largely reflecting lower FX revaluations gains, and a 30% decline in trading income. Consequently, PBT should print at N208 billion (FY 17: N203 billion). We think loan book will fall materially short of management guidance (10% YoY), almost flat at 2% YoY, but see an expansion in investment securities (+7.5% YoY). Deposit book should expand 4% YoY.
In our view, Zenith’s relatively attractive valuation and discount relative to GTB could see the stock re-rate in the short term. Longer term, modest growth in loan book (avg: 7%) and growth in fee income should support earnings growth. Based on our estimates, our fair value for Zenith, assuming a cost of capital of 21% and long-term growth rate of 5%, is 1.50x its forward book value. This would imply 30% upside potential to its current valuation of 1.17x.
Elsewhere, we downgrade our rating on GTB from ‘OVERWEIGHT’ to ‘NEUTRAL’ on the back of a drop in our FVE to N49.02/share (previously: N55.20/share), following: i) downward revision to net loan growth in FY 17 to 3.3% YoY (previously: 7%); and ii) an upward revision to NPL ratio and CoR to 5% and 0.5% respectively (previously: 3.5% and 0.3%), albeit at healthy levels. Consequently, loan loss provision should print at N7.5 billion (-39% YoY). Irrespective, we revise our NIR higher to N72 billion, though lower by 20% YoY due to sizable decline in FX revaluation gains.
However, our upward revision in NIR reflects steady growth in fee income (card related fees, account maintenance fee, and FX commission) as well as trading income on treasury bills trading and FX transactions relating to forward position which are pure trade transactions entered into between the customers of the Bank and CBN and awaiting settlement in CBN forward window. On the funding income and expense leg, we expect a 9% YoY increase in deposit and a 120bps YoY expansion in CASA deposit to 81%. NIMs should print at 9.2% (previously: 9.0%) with net interest income printing at N268 billion (+9% YoY). Consequently, we forecast gross earnings of N427 billion (+2.4% YoY) with cost to income ratio of 37.6% (+80bps YoY). Hence, we expect PBT of N204 billion (management guidance: N205 billion, FY 17: N200 billion). EPS should print at N6.12 (6% YoY).
While GTB remains a compelling investment case, we think growth is topping out and the valuation gap relative to Zenith will shrink a touch in 2018, and thus recommend a tactical approach to exposure. GTB trades at a current and 2018 P/B of 2.4x and 1.8x relative to Zenith of 1.2x and 0.9x respectively, implying a contraction in valuation gap to 86.5% (currently: 108.5%).
Based on our estimates, our fair value for GTB, assuming a cost of capital of 21% and long-term growth rate of 5%, is 2.7x its forward book value. This would imply 11% upside potential to its current valuation of 2.44x. Both banks are expected to report lower ROAE in FY 18 of 26.3% (GTB) and 20.6% (ZENITH) relative to 28.3% and 23.5% in FY 17.
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Finishing Strong in 2017
Over 2017, GTB and Zenith saw a decent boost in net profit of 34% and 37% respectively.
Irrespective, earnings driver differed substantially. While GTB’s earnings growth reflected higher NIM led topline growth as well as lower loan loss provisioning, earnings growth of Zenith was largely driven by robust income on the trading and derivative line.
Zenith’s strong EPS growth over 2017 (+37% YoY) largely stemmed from strong trading income on treasury bills (+928% YoY to N88.9 billion) and FX (+242% YoY to N68.7 billion) which drove robust growth in non-interest revenue (NIR) to N270 billion (+119% YoY). The sizable trading income on both treasury bills and FX emanated from its derivative position (est. optional value: $2.5 billion) with FX income representing net gains on forward contracts while treasury bills income reflects trading income from its swap position. On the negative, despite a fairly liquid balance sheet and higher yields on investment securities and loans, NIM shrank 7bps YoY as funding costs tracked higher.
Looking at the breakdowns, higher interest expense stemmed from increased cost on borrowings (+142% YoY) which Management linked to the impact of the additional $500 million Eurobond issued in 2017 even as elevated interest rate environment expanded funding cost on current deposit (+143% YoY).
For GTB, EPS growth over 2017 (+34% YoY) mainly reflected higher interest income (25% YoY to N327 billion) driven by higher yields on investment securities which drove overall asset yields 190bps higher YoY. Consequently, despite a rise in funding cost (+64bps YoY to 3.4%), NIMs expanded by 154bps YoY to 9.0%. Elsewhere, despite strong growth in trading income (117% YoY), a 65% drop in other income (mainly due to materially lower FX revaluation gains), drove NIR lower by 40% YoY). Irrespective, material decline in loan loss provision (-81% YoY) supported earnings growth over the period.
Financial Summary of FY 17 result
Zenith Bank Plc
Decent start to 2018…but some twist to earnings driver
GTB and Zenith released first quarter result showing some resilience in performance, and more surprisingly, a significant change in earnings driver when compared to prior quarter.
For both banks, while loan book declined QoQ, investment securities expanded QoQ indicating a premeditated strategy to grow the treasury bills book in the face of lower yields, thus supporting interest income in absolute terms. Loan loss provision declined materially QoQ with asset quality showing sizable improvement relative to prior quarter.
Zenith reported EPS of N1.50 (-3.3% QoQ) due to substantially lower NIR (-74% QoQ), emanating from lower trading (-98% QoQ) and FX revaluation gains (-37% QoQ). That said, NIMs expanded 360bps QoQ to 8.6% reflecting higher asset yield (+220bps QoQ to 10.7%) and lower funding cost (-93bps QoQ to 4.1%). The higher yield on assets emanated from a double-fold increase in interest income from treasury bills, but not philosophical of falling interest rates.
Operating expenses expanded 15% QoQ as AMCON charge of N12 billion (c.50% of annual charge) was booked in the period. Reflecting the foregoing as well as lower NIR, Cost to Income ratio deteriorated to 52% (Q4 17: 35%). Asset quality improved as evident in Cost of Risk – which declined to 1.0% (Q4 17: 9.7%) – and slight improvement in NPL ratio to 4.3% (-40bps QoQ).
Guaranty Trust Bank (GTB) first quarter result was quite impressive as strong growth in fee and trading income as well as lower provisioning saved the day for PBT which expanded 4.8% QoQ to N52.6 billion.
Irrespective, higher payment to the taxman (+50% QoQ) dragged EPS marginally lower to N1.52 (Q4 17: N1.53). In terms of the earnings, Net interest income increase of 4.5% QoQ largely reflected the decline in interest expense (-4% QoQ). Irrespective, net interest margin (NIM) moderated to 10.09% (Q4 17: 10.8%) on the back of a 60bps QoQ moderation in asset yields.
Further, despite a sharp jump in fee and trading income, lower FX revaluation gain drove a 10% QoQ decline in non-interest revenue (NIR) which moderated the 57% QoQ decline in loan loss provisioning. Much of the jump in NIR emanated from a 370% QoQ increase in fee income as well as a 268% QoQ expansion in trading income. A key driver for Q1 earnings was the sharp decline (-57% QoQ) in loan loss provision with Cost of Risk contracting to 0.11% (Q4 2017: 1.1%).
The decline, reflected zero provisioning on the specific and collective leg over the quarter. However, in line with IFRS 9, GTB booked N1.5 billion on 12-month expected credit losses (ECL) and N581 million life-time ECL impairment. According to Management, post Q1 2018 result, 65% of exposure to 9mobile has been provided for. Thus, NPL ratio printed at 6.2% (Q4 2017: 7.7%)
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