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Investment Recommendation Report – Equity


Faida Research - May 22, 2020 - 0 comments

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We recommend a LONG-TERM BUY on Equity Group Holdings. The counter is currently trading at a trailing P/B of 1.22x (at a price of KES 36.15) compared to the banking sector P/B of 0.77x as at 22nd May 2019. Our recommendation is based on the company’s i) Superior digital banking capabilities ii) Agile balance sheet- liquidity ratio of 52.1% and core capital/risk weighted asset ratio of 19.8%.

Key Drivers

  • We expect the bank to continue reaping the benefits of its digitization strategy. With the current economic shock due to COVID-19, we expect the bank to leverage on its robust digital capabilities to increase its service offering on digital platforms. As at FY2019, 97.0% of all transactions took place on alternative channels. We expect to see a significant growth in retail transaction numbers on mobile and internet banking.
  • With expected retail migration to alternative channels, we see potential for improved efficiency. The group has recorded a 3-year declining trend in its cost to income ratio(C/I) from 53.5% in FY2017 to 51.0% in FY2019.

Key Risks

  • We expect to see asset quality deterioration should the COVID-19s economic impact worsen with expected default to hit SMEs the hardest (59% of Equity’s loan book). The NPL ratio and cost of risk as at FY2019 stood at 9.0% and 1.3% respectively. From a sectoral perspective, manufacturing, trade, transport, agriculture and personal loans will bear the brunt. The group’s total contribution to these sectors is a total of 62.0%. We expect this to be partially mitigated by the bank’s strong liquidity position further supported by its adequate capital adequacy ratios.

 

In adaptation to challenges brought up by COVID-19, Equity has:

  • Increased services on its digital platforms targeting especially retail and SMEs and introduced online forex trading and web banking for ‘chamas’ (informal cooperative societies).
  • Customers with existing loan facilities can renegotiate terms.
  • Free bank to mobile transfers.
  • No charge on customers using cards to pay bills, utilities, shopping, fuel as well as other services.
  • Activation of digital account opening and management of mobile and internet apps.
  • Debit and prepaid cards both Visa and MasterCard now contactless.

We expect some of these measures to lead to lower NFI.

FY2019 Results Commentary

  • Equity Group reported a 14.1% y/y growth in profit after tax at KES 22.8 billion, in line with expectation. RoAE increased to 21.8% from 21.1% in FY2018 while RoAA was flat at 3.6%.
  • Interest income grew by 12.2% y/y to KES 59.7 billion. Interest expenses grew by 24.6% y/y to KES 14.7 billion as cost of funds grew by 20bps y/y to 2.9%. As a result, net interest margin grew by 8.7% y/y to KES 45.0 billion (NIMs declined by 20bps to 8.3%)
  • Non-funded income grew by 19.1% y/y, above our estimates driven by bond trading income (+122.0% y/y), Eazzy Platform (+82.0%y/y) and mobile banking income (+15.0%). Non funded income contributed 40.0% to total income from 38.0% in FY2018
  • Loan loss provision significantly increased by 51.7% y/y to KES 4.4 billion. Gross NPLs ratio rose to 9.0% from 7.6% in FY2018 driven by the SME (NPL ratio 11.3%) and Large enterprises (NPL ratio 9.4%) segments. As a result, cost of risk went up to 1.3% from 1.0%.
  • Other operating expenses grew by 9.5% y/y to 38.2 billion. Despite this, cost to income ratio declined to 51.0% from 52.4% in FY2018 as a result of the digitization strategy, signalling improved efficiencies.
  • In line with expectation, there was a reallocation of funds from government securities (y/y growth of KES 7.0 billion) to the loan book (23.3% y/y growth to KES 366.4 billion). Loan book segmentation included: 59.0% SMEs, 22.0% consumers, 13.0% large enterprises, 3.0% agriculture and 3.0% micro enterprises.
  • Growth in loan book was also funded by customer deposits, which grew by 14.2% y/y to KES 482.2 billion and 26.0% growth in borrowings.
  • As highlighted in the banking sector report, the group continued to record positive performance in its subsidiaries’ performance. Subsidiaries accounted for 18% and 27% of group’s total assets and PAT respectively.

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