We recommend a LONG-TERM BUY on Equity Group Holdings. The counter is currently trading at a trailing P/B of 0.97x (at a price of KES 28.75) compared to the banking sector P/B of 0.66x as at 14th August 2020. It’s also trading at a 39.8% discount to its 3-year average P/B multiple of 1.61x. Our recommendation is based on the company’s i) Superior digital banking capabilities ii) Agile balance sheet- liquidity ratio of 51.6% and core capital/risk weighted asset ratio of 17.5%. iii) Growth in non-funded income. The group remains fundamentally sound hence our recommendation to investors with a long term view.
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. With that in mind, the current waivers on mobile banking transaction fees (now up to 330th December 2020) are expected to impact mobile banking fees for FY2020. As at 1Q2020, 97.0% of all transactions took place on alternative channels. 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 49.0% in 1Q2020.
Prior to COVID19, during the interest rate cap regime, the group adopted a new model strategically reducing income volatility from interest income which we expect to sustain during this period. As at 1Q2020, non-funded income growth grew by 16.0% y/y, faster than the 11.0% growth in net interest income, now contributing 42.0% of the group’s total income. While we expect decline in mobile banking commissions for FY2020, we foresee a boost in forex trading and merchant banking commissions to offset this decline. As at 1Q2020, forex trading income grew by 34.0% y/y to KES 1.1 billion while merchant banking grew by 11.0% to KES 582.0 million.
Given the low interest rate environment and challenges in lending, we expect the group to mitigate expected reduced interest income from lending in 2Q2020, by increasing investment in government securities. As at 1Q2020, government securities portfolio was up 10.0% q/q to KES 189.9 bn (FY2019: KES 172.0 bn). Interest in government securities as at 1Q2020 accounted for 74% of Treasury income mix and treasury income accounting for 30% of total interest income. We expect the group to continue on this conservative approach for the rest of FY2020.
We expect the group to focus more on regional economies, spreading its business risk. As at 1Q2020, the group was present in 7 countries, with regional subsidiaries contributing 23.3% to PAT with and an average ROaE of 19.5%. While we are positive on business diversification though regional expansion, we remain concerned around: i) high cost of running these subsidiaries (average cost to income ratio of about 64.1%) ii) economic shocks within all subsidiaries due to the pandemic has potential to drag out group’s overall profitability.
We remain concerned with the group’s deteriorating asset quality which we expect to experience further pressure owing to COVID19 pandemic. As at 1Q2020, the group’s gross non-performing loans increased by 21.3% q/q to KES 44.6 billion from KES 36.3 billion as at FY2019 (+51.9% y/y) as the cost of risk grew from 0.4% in 1Q2019 to 3.2% (1Q2020). NPL per sector was highest in SMEs and Large Enterprises at 12.5% and 13.2%, giving rise to an overall NPL ratio of 10.9%. From a country perspective, South Sudan and Tanzania recorded an NPL ratio of 40.8% and 40.5% respectively. The hardest hit sector is expected to be SMEs and large enterprises (72.0% of total loan book) with large exposures within the trade (25%) and real estate sector (22.0%). We therefore expect the NPL ratio to deteriorate further for FY2020.
1Q2020 Results Commentary:
Equity Group’s after-tax profits for 1Q2020 declined by 14.1% y/y to KES 5.3 bn. The group’s profits were weighed down by an increase in:
i. Loan loss provisions which rose by 660.4% y/y to KES 3.1 bn as the group enhanced its level of provisioning to manage expected risks.
ii. Operating costs which increase by 16.3% y/y to KES 9.7bn.
The higher provisioning was underpinned by a 51.9% y/y rise in gross non-performing loans to KES 44.6 bn – leading to an NPL ratio (gross non-performing loans/gross loans) of 10.9% (1Q2019: 9.0%)
o The sectors that recorded the highest NPL ratios were large enterprises, SMEs and agriculture at 13.2%, 12.5% and 9.1% respectively.
o South Sudan and Tanzania had significantly higher NPL ratios at 40.8% and 40.5% respectively compared to the rest of regional subsidiaries; DRC at 11.7%, Rwanda at 4.1% and Uganda at 3.2%.
Operating costs were driven by:
i. Staff costs which increased by 23.0% y/y to KES 3.2 bn ii. Other expenses which rose by 22.7% y/y to KES 4.8 bn
Consequently, the group’s cost-to-income ratio edged up to 49.2% (1Q2019: 47.8%).
Total interest income grew by 14.3% y/y growth to KES 15.4 bn supported by an 18.7% y/y rise in interest income from loans and
advances to KES 10.8 bn. The growth in interest income from loans and advances and this was due to a 24.1% y/y rise in the group’s loan book (net loans) which outweighed a 50 bps dip in the yield on loans (to 11.6%).
Total interest expenses increased by 26.7% y/y to KES 3.9 bn on the back of:
o A 143.4% y/y increase in other interest expenses (from borrowings) to KES 926.7 mn due to a 3.2% y/y growth in borrowings to KES 52.6 bn.
o A 12.0% y/y rise in interest expenses arising from customer deposits to KES 2.8 bn on the back of a 16.5% y/y growth in customer deposits to KES 499.3 bn. However, cost of customer deposits eased slightly by 10 bps to 2.3%.
The group realized a net interest income of KES 11.5 bn (reflecting a growth of 10.6% y/y) and a NIM of 7.6% (1Q2019:8.2%). The lower NIM was a result of a faster growth in interest earning assets (+17.0% to KES 604.2 bn) vis-à-vis the growth posted in net interest income.
Non-funded income grew by 15.8% y/y to KES 8.3 bn (mainly driven by a 16.8% y/y rise in other fees and commissions to KES 4.0 bn) resulting in a 110-bps increase in the proportion of non-funded income to total income to 41.9% (1Q2019: 40.8%).