Zenith Bank Plc Earnings Update - More Prudence as Bank Adopts New Impairment Model


Tuesday, August 16, 2016 11:21am /CardinalStone Research

Zenith Bank Plc (Last TP: N24.04, Rating: BUY) held its conference call last week. Please see below the group's H1'16 performance update and key highlights from the call.

Management retains N102 billion as FY'16 PAT guidance
Despite the setback in H1'16 performance (PAT down by 16% YoY to N44.8 billion), management during its conference call retained its earlier PAT guidance of N102 billion by FY'16. Earnings as at H1'16 was about N6 billion shy of management's prorated guidance which was due to the marked increase in total tax expense as a result of the FY'15 dividend paid in Q1'16.

Management however, expects its tax rate to normalize to 19% in FY'16 from 29% in H1'16 as the tax on dividend paid will not be significant in the second half of the year. Also, management expects higher asset yield and account maintenance charges to support 2016 earnings.

Management says its focus is on core operation income and not revaluation gains
Contrary to consensus expectation, Zenith bank did not book any revaluation gain following the 40% Naira devaluation in June 2016.

Management explained that its decision not to keep a net long position in foreign currency was deliberate as the bank chose to focus on core banking activities and used its foreign currency position to fund FX-related transactions and letter of credits as against setting aside up to 20% of its shareholders fund in foreign currency.

As at H1'16, Zenith Bank was slightly short on the dollar to the tune of N82 billion. However, management said all its short position has been squared out as at the conference call date. Therefore, we do not expect FX revaluation gains in Q3'16.

Management remains upbeat on its upstream oil & gas assets
As at H1'16, Zenith Bank's upstream oil and gas portfolio was 9.5% of total loans (up from 7.9% as at Q1 as a result of devaluation). Following the restructuring of some of the bank's upstream oil & gas assets, management said most of its upstream loan facilities are performing.

On its exposure to Aiteo, management stated that the company's production volume has improved despite  challenge in the Niger Delta region and thus does not envisage any difficulties barring a drastic drop in oil prices.

Management also mentioned that its Seplat exposure is performing (principal and interest payment are up to date) despite the production challenges faced by the company.

Bank adopts new impairment model
Given current macroeconomic challenges, the bank has adopted a new impairment model which takes into consideration prevailing macro-economic trends in generating the required provisions on its credit asset.

Based on the new model, it's sometimes mandatory to take provisions on performing loans; this was why the bank's coverage ratio increased to 110% in H1'16 from 97% in FY'15. Zenith Bank's capital adequacy ratio (CAR) declined to 17% mainly as a result of the Naira devaluation.

Management however said it does not have plans to raise capital soon and that if Naira devaluation continues,it will switch some of its asset from FCY loans to government securities to improve its capital adequacy.

Final Verdict – solid fundamentals, proactive risk management, BUY rating maintained
The bank's PBT of N63 billion was actually in line with management's guidance and the deviation in after tax earnings was due to the spike in tax expense.

Therefore, we are quite impressed that despite the absence of revaluation gains, the bank posted a stellar performance considering current economic challenges.

We are also comfortable with the bank's asset quality (NPL ratio at 2.3% versus industry average of 8.36%; Cost of risk at 1.3% versus industry average of 3.1%, as at H1'16).

The new impairment model, which attests to the bank's proactive risk management practice, will also improve confidence in Zenith Bank. Therefore, we maintain our TP and retain a BUY rating on the counter.

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