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Investment Recommendation Report: Equity

- May 31, 2019 - 0 comments

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We recommend a LONG TERM BUY on Equity Group Holdings. Currently, Equity is trading at a P/B of 1.54x (at a price of KES 38.85 compared to the average banking sector P/B of 0.84x as at 31st May 2019. We attribute the high P/B ratio to high growth expectations by investors. Equity has a high ROaE of 21.1% (the second highest in the banking sector) which is well above the industry average of 13.5%.

The current business model, hinged on technology, innovation and business diversification affirms the group’s competitive advantage in an industry adapting to the digitization strategy amidst the current regulatory challenges. Thus, we believe this business model will support growth in the long-term. The group’s business model is tailored to address the emerging challenges in the banking sector. The model is hinged on the following focus areas:
• Non funded income growth – to support net interest income
• Regional diversification – to mitigate against regulatory risk
• Strengthening liquidity and balance sheet agility
• Treasury operations – to enhance treasury income
• Asset quality (especially with tougher regulations in the horizon)
• Innovation and digitization
• Efficiencies and cost optimization

In a bid to increase their footprint across Africa, the bank is set to acquire four banks in Rwanda, Zambia, Tanzania and Mozambique. Equity Bank expects to acquire 62% stake in Banque Populaire du Rwanda and full ownership of BancABC Zambia, BancABC Tanzania and BancABC Mozambique in a share- swap deal with London-listed Company Atlas Mara. This will expand the bank’s operations to 8 countries within the African Continent.

1Q2019 Results commentary:
The Group registered a 4.9% y/y growth in after tax profits to KES 6.2 billion from KES 5.9 billion posted in 1Q2018. The performance was characterised by growth in both net interest income (+6.3% y/y to KES 10.4 billion) and non-funded income (+6.9% y/y to KES 7.2 billion) and a rise in operating expenses (including provisions) by 7.0% y/y to KES 8.8 billion. The main highlights were the recovery in the contribution of non-funded income to total income which had dipped in 1Q2018 and the continued underperformance in Tanzania. Additionally, the Group’s asset quality deteriorated as the NPL ratio rose to 9.0% (1Q2018: 6.3%) mainly due to the challenging business environment in Tanzania as well an increase in non-performing loans in the SME and large enterprise sectors in Kenya. C/I (excl. provisions) remained flat at 47.5%.

Going forward, the bank is keen on growing non-funded income in Tanzania (for instance, through merchant commission) and improving the quality of its loan book (lend less to the real estate sector and focus more on other sectors such as the consumer sector). In 1Q2019, the bank’s subsidiaries contributed 17.0% to the profits before tax (KES 1.5 billion). The bank is in the process of acquiring four banks from Atlas Mara. The move will see it expand its operations in Tanzania and Rwanda (through merging with existing subsidiaries) and enter into Zambia and Mozambique markets. The acquisitions are part of its strategy to operate in fifteen countries by FY2024. We opine that the acquisition of the four new banks will help build economies of scale for the bank.

The bank is focused on lending more to customers and investing less in government securities (due to the decline in the yield on government securities). We opine that this shift will see an increase in the bank’s cost of risk. Additionally, the bank is collaborating with Safaricom to enhance customer access to financial services, a partnership which it expects will grow its funded and non-funded income.

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