Earnings Flash: United Bank for Africa Plc - Assessing pending resolution of Air Nigeria on a valuat

Proshare

Tuesday, December 11, 2012, / ARM Research

United Bank of Africa PlcUBA” hosted a conference call on 19th October where management shed more light on recently released 9M 12 financials. It was however silent on the issue that is perhaps the most salient for investors’ – the Air Nigeria loan--beyond remarking that resolution was expected in Q4 2012. With Q4 nearing its close, we followed up with UBA on this particular issue as well as others touching upon its operations and outline the key points below:

Domestic business still in consolidation mood
•Risk appetite still low: During the conference call, the Group CEO reaffirmed a loan growth target of 4-7% for 2012--having achieved 4% in 9M 2012--citing a need to grow risk assets more slowly after recent mishaps. In light of this and despite significant cuts in our loan growth estimates after a 4% QoQ contraction in 9M 12, our current N749 bn estimate (which implies an 11% YoY growth for FY 12E) still appears aggressive. Accordingly we have made further cuts to our loan growth estimates through 2014 though the overall impact of these on our revenue estimates is offset by earnings from securities and money market assets which is in line with UBA’s new focus on Treasury activities to drive revenue growth. The CFO had asserted at the call that most of the bank’s current non-interest revenue is from e-banking and remittances.

To explain why the bank’s asset yields were lower than peers (9M 12: 8% vs 11% for peers), the CFO attributed this to increased composition of foreign currency loans and its higher proportion (relative to peers) of HTM bonds that were purchased at low yields in security portfolio. Foreign currency loans currently comprise 30% of risk assets with yield between 0.5-2%. Our forecast assumptions cap yields at 8.5% over our forecast horizon and a downward revision in our loan growth estimates results in a 200bps reduction in revenue CAGR to 8% over this period.

•Focused on low-deposit mobilization: While acknowledging that it has slipped to second place behind First Bank in terms of branch network, UBA nevertheless considers its current footprint large enough to drive its low-cost deposit mobilization.  Management hinted at plans to push new incentives like lower charges and less stringent account opening requirements and indicates low-cost deposits now account for 83% of total deposits which helped drive WACF down 10bps in Q3 12. This broadly reflects our views and we have left our estimates for a further 10bps dip to 3.3% by FY2012 unchanged.

•Operating costs coming under control, revenue growth to drive CIR: UBA expects opex to hold steady around current levels and sees revenue growth and tighter cost control in foreign subsidiaries underpinning further moderation in CIR. The beneficial impact of ongoing centralization of back-end operations and consequent effect on staff costs is reflected in lower levels of opex compared to the preceding three years with current CIR of 62% - ~13ppt below FY2010 levels. Management expects CIR to trend below 50% over the next few years. We are somewhat less optimistic on this front and maintained a 60% floor on CIR over our forecast horizon in view of slower than expected revenue growth and our belief that efficiency gains will take longer to materialize than the bank expects.

The CFO also explained relatively low tax rate of 13% was a consequence of applying exemptions on government securities as well as harvesting tax losses from African subsidiaries.

•Monoline replaces HoldCo model as African subsidiaries’ importance grows: After initially opting for the HoldCo model, the bank had to readjust its plans to focus on core banking as CBN clarified that Registrar businesses would not be permitted for banks even under HoldCo. Accordingly, Afriland properties, Africa Prudential Registrars as well as UBA capital (which jointly contribute <3% of UBA’s business) are all to be spun off to current shareholders with the latter two to be listed. However, current international banking subsidiaries including New York and Paris will be retained under an international banking license. This proposed structure is expected to be ratified by shareholders at a court-ordered meeting in a few days.

 UBA currently has 19 subsidiaries across Africa and the Group CEO affirmed that the share of its Africa business has increased from 12% of overall revenues in 2010 to 23% currently.  He added that the Africa business was focused on capturing growing intra-Africa trade and that a significant portion of revenues was derived from fees and exchange rate commissions as the focus was on intermediation rather than providing credit to trading parties.

The CEO of UBA Africa corroborated the progress being made by asserting that subsidiaries in 14 countries were currently profitable with the rest expected to break even by FY 12. Focusing on the Ghana subsidiary (with 23 branches) as an example, he highlighted its rapid revenue growth, efficient balance sheet usage and 90% low-cost deposit contribution which were reflected in that subsidiary’s NIMs and ROE of 21.5% and 24% respectively, compared with 5.9% and 27% for the parent.

•Air Nigeria outlook not particularly rosy: Management took pains to buttress the extent of risk aversion in its strategy both during the conference call and our chat with its zero exposure to downstream oil & gas often served up to highlight the extent of efforts to avoid problem areas. Removing the Air Nigeria loan, UBA’s NPL ratio falls from 6.8% to 2.2%.

However, citing banker-client privilege, management was somewhat reserved in providing information on the N34bn loan to Air Nigeria which has since ceased operations. The crux of management discussions during the conference call was that the bank took a N3.4bn charge in 9M 12 but expected this to reverse with a final resolution on the loan’s status in Q4 12. However during our follow up chat, it admitted that negotiations for disposing the loan would most likely extend beyond current financial year and further charges would be inevitable in Q4 but reaffirmed its expectation of a post-resolution reversal of the associated charges.

We deduce that the bank is looking to a sell to AMCON or concede a strategic stake to the FG as possible exit routes. We nevertheless note that the impact of this impairment does not impede the expected single digit growth over the medium term given the a one-time impairment charge for the loan will take tier 1 CAR to 16% and total CAR to 21% by our estimates (current CAR: 24%), both of which are still well ahead of regulatory requirements.

•Key Conclusion: Price declines outweigh valuation impact: We reassess fair value under various loan-provisioning scenarios for the Air Nigeria exposure, after incorporating other adjustments to capture slower revenue growth.. We work with a total outstanding of N30.6bn after netting the N3.4bn charge taken in Q3 12. Our scenarios incorporate a 100% charge as the worst case and a 50% charge as the best but we made further distinctions among various timelines over which these charges could be taken under IFRS.



•The stock has declined 20% since our last update, likely reflecting concerns over the Air Nigeria issue. However this decline is significantly ahead of the valuation impact of our worst case scenario. Current valuation multiples of 3.7x forward 2012 PE and 0.8xP/Bv compare favourably to peers’ 6.22x and 1.4x respectively. In view of the further upside the decline has created, we upgrade the stock to BUY from OVERWEIGHT.


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