Monday, August 14, 2017 10:20AM / Vetiva Research
• High interest rate environment lifts top line despite flat loan growth
• Elevated OPEX and Interest cost persist
• Provision in Power and Telecom assets pressure asset quality
Marked deviations from estimates as earnings beat
ZENITHBANK released its audited H1’17 result posting marked deviations from our expectations across most line items. Notably, following a 58% q/q rise in Gross Earnings in Q2’17 standalone, the top line rose 77% y/y to ₦380 billion for the H1’17 period – beating our ₦282 billion estimate.
Particularly, despite a 3% decline in loans and advances, Interest Income rose 45% y/y to ₦262 billion (Vetiva: ₦226 billion) – supported by a strong interest rate environment. In the same vein, Interest Expense spiked 127% y/y to ₦123 billion following a significant uptick in cost of funds (H1’17: 6.4% vs. H1’16: 3.2%) – coming in higher than our ₦89 billion estimate.
Consequently, Net Interest Margin moderated 40bps y/y to 7.7% (Q1’17: 8.7%). More conspicuously, Non-Interest Income rose to ₦118 billion (H1’16: ₦34 billion) – dwarfing our ₦55 billion estimate. Particularly, the bank recorded an FX trading income of ₦46 billion – largely driven by income from forward contracts within the period.
Also, T-bills trading income rose significantly to ₦18.8 billion from ₦2.2 billion in the prior year. Fee and commission income growth however came in more modest, up to ₦38 billion from the ₦31 billion recorded in H1’16. Amidst rising NPL ratio (H1’17: 4.3% vs. Q1’17: 3.2%), ZENITHBANK reported a significant rise in loan loss provision, up 198% y/y to ₦42 billion vs. our ₦16 billion estimate. According to management, the increase in impairment charge was largely driven by higher provisioning across the Power and Telecoms sectors.
We recall that ZENITHBANK had the highest exposure to Etisalat and believe the bank must have taken a conservative approach to make provision for a portion of their exposure to the telecoms company. Despite this, Operating Income rose 47% y/y to ₦215 billion – 22% ahead of our ₦176 billion estimate.
Surprisingly however, Operating Expense rose substantially in Q2’17, up 54% q/q – a trend management attributed to inflation and currency pressure despite a relatively more stable FX environment and a sticky downward inflationary trend within the period.
Not with standing, PAT rose to ₦75 billion – beating our ₦65 billion estimate. We highlight that ZENITHBANK restated its prior year’s profit, expensing an AMCON levy of ₦9.4 billion which had previously been capitalized. Hence H1’16 PAT was restated to ₦35.5 billion (Previous: ₦44.8 billion). Overall, the Board declared an interim dividend of ₦0.25 per share – same as prior year and in line with our estimate.
Earnings revised higher on higher interest rates
We have updated our model to reflect the marked deviations across most line items.
Whilst we cut our loan growth forecast for FY’17 to a mild 2% (Previous: 8%), we raise our Interest Income estimate to ₦535 billion (Previous: ₦452 billion) – supported by the strong interest rate environment. Similarly, we raise our Interest Expense forecast for FY’17 to ₦245 billion (Previous: ₦178 billion), pressured by the elevated funding cost.
Also, following the outperformance in H1’17, we revise our NonInterest Income higher to reflect the spike in FX income from forwards and futures transaction recorded in Q2’17. Despite the raise, we remain conservative about the persistence of this income line in the coming quarters and taper down the run rate for the year. Driven by the impairment in asset quality observed over the second quarter, we double our loan loss provision expectation for FY’17 to ₦66 billion (H1’17: ₦42 billion) – translating to a cost of risk of 2.9%.
Furthermore, in line with the trend observed in Q2’17, we raise our Operating Expense estimate to ₦254 billion (Previous: ₦191 billion). Overall, our PAT forecast is raised to ₦143 billion (Previous: ₦131 billion).
We revise our target price to ₦30.73 (Previous: ₦28.00)
Whilst we see the recent uptick in NPL ratio (H1’17: 4.3% vs. Q1’16: 3.2%) as a pressure point for earnings in the coming quarters following the restructuring of Etisalat’s loan exposure and the subsequent takeover, we highlight ZENITHBANK’s impressive liquidity and capital ratios. With capital adequacy and liquidity ratios of 21% and 61% (regulatory benchmark of 15% and 30%) respectively, we believe the bank is well positioned to take advantage of the market opportunities.
Given the earnings outperformance, we revise our target price to ₦30.73 (Previous: ₦28.00). Although we have seen a strong rally in the stock in recent time (ytd return: 63%), we believe the bank remains largely undervalued. ZENITHBANK trades at FY’17 P/B: 1.0x and P/E: 5.8x vs. Tier I banks’ average P/B: 1.1x and P/E: 5.8x respectively.
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