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Investment Recommendation Report – Absa Kenya

- June 26, 2020 - 0 comments

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We recommend a LONG-TERM BUY on ABSA Bank with the counter trading at a P/B multiple of 1.21x (at a price of KES 10.10) against an industry average of 0.75x as at 26th June 2020. The counter has a high ROaE of 16.7%, which is above the industry average of 15.6%. Additionally, the counter has the highest dividend yield at 10.9%, higher than the industry average of 5.1%.

Our recommendation is based on:

Key Drivers
 We expect that if applied successfully, the new 5-year strategy would see the bank grow its non-funded income contribution to total operating income.

 We also expect the new strategy to boost operational efficiency. The Bank has been leveraging its investments in technology to improve operational efficiency. This has notably been evidenced through the reduction in the number of traditional branches and focus on alternative banking channels (mobile and internet banking).

 We note that the bank has the potential to maintain its market share as it pursues the new five-year strategy which partly focuses on increased lending.

 Following the separation from Barclays PLC we expect the bank to utilize this new ‘freedom’ to pursue new products more tailored towards the local market.

 We note that the two years (FY2018 and FY2019) into implementation of the new 5-year strategy the bank has recorded improvements in ROaE, cost to income ratio and non-funded income contribution.

Key Risks

 The bank’s market share growth is dependent on the bank’s ability to grow ahead of competition or at least not lose any more ground. Given the bank’s conservative approach in the past, this is likely to be a challenge.

1Q2020 Results Commentary

 ABSA Kenya reported a 3.0% y/y growth in after tax profits to KES 2.0 billion (1Q2019: KES 1.9 billion). The performance was characterized by a 15.8% y/y increase in non-funded income to KES 3.0 billion and a 5.4% y/y decline in operating expenses (excluding provisions) to KES 4.1 billion.

 Total interest income grew by 2.8% y/y to KES 7.6 billion primarily driven by a 7.5% y/y increase in income from government securities to KES 2.1 billion (the bank’s holdings of government securities edged up by 7.2% y/y to KES 125.4 billion while the yield on government securities dropped to 6.7% from 7.4% in 1Q2019).

 Income from loans and advances rose by 1.0% y/y to KES 5.5 billion on the back of a 12.4% y/y growth in the net loan book to KES 203.0 billion.

 Total interest expenses declined by 1.9% y/y to KES 2.0 billion predominantly owing to a 13.2% y/y decrease in interest expenses from customer deposits to KES 1.6 billion. Although customer deposits increased by 6.6% y/y to KES 238.7 billion (1Q2019: KES 224.0 billion), the cost of deposits fell to 2.6% from 3.3% in 1Q2019.

 Consequently, net interest income edged up by 4.5% y/y to KES 5.6 billion. The net interest margin dipped to 6.9% (1Q2019: 7.5%) due to a faster growth in interest earning assets (+10.1% y/y to KES 330.4 billion).

 Non-funded income realized a 15.8% y/y growth to KES 3.0 billion supported by a 47.4% rise in foreign exchange trading income to KES 1.1 billion. Fees and commissions on loans and advances grew by 8.8% y/y to KES 390.7 million. However, other fees and commissions declined by 3.0% y/y to KES 1.1 billion. The contribution of non-funded income to total income grew to 34.5% (1Q2019: 32.2%).

 Operating expenses (excluding provisions) fell by 5.4% y/y to KES 4.1 billion owing to: i) an 18.4% y/y dip in other expenses to KES 1.1 billion and ii) an 84.0% y/y drop in rental charges to KES 23.7 million. The cost to income ratio (excluding provisions) improved to 47.1% (1Q2019: 53.9%).

 According to management, following the separation from Barclays PLC, the bank will continue to make substantial investments in systems and rebranding over the course of the next two years; as well acquire various services from Barclays PLC.

 Loan loss provisions surged by 75.2% y/y to KES 1.1 billion as gross non-performing loans increased by 12.45 y/y to KES 17.3 billion. The NPL ratio (net gross/net loan book) grew marginally to 3.0% (1Q2019: 2.8%).

 The separation costs increased by 126.8% y/y and amounted to KES 552.1 million. According to the bank, adjusting for this non-recurring “exceptional” item (non-recurring in the long-term), the bank posted after tax profits growth of 13.0% y/y to KES 2.3 billion.

 We note that the decline in interest expenses was on the back of a dip in customer deposit expenses which fell, in line with the bank’s strategy to lower its cost of deposits. We are optimistic about the bank’s focus on cheaper deposits.

 We are optimistic about the increased NFI contribution. However, we note with concern the decline in other fees and commissions which had recovered in FY2018 (attributed to the growth of the Timiza platform). In light of the Covid-19 pandemic, the bank has waived fees on digital transactions and provided loan relief options (including loan repayment relief of up to twelve months).

 We note the bank’s cost management efforts have resulted in continued improvement in the cost-to-income ratio (C/I) which has fallen below industry average (previously was the highest among Tier 1 banks in FY2017).

 We expect more caution on lending, particularly to the sectors largely affected by the crisis such as the SME sector. This may see reduced lending through the bank’s Wezesha Bishara proposition through which the bank offered unsecured loans to SMEs. We note the bank, as part of its new strategy had gradually started including more risky segments such as SMEs in its lending strategy. We expect resumption once the economy stabilizes.

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