We place a LONG-TERM BUY recommendation on NCBA Group. The counter is currently trading at a P/B ratio of 0.62x (based on a market price of KES 27.80 as at 5th June 2020) lower than the industry average P/B of 0.74x.
Given the economic uncertainties brought on by the pandemic, we expect the group’s financial performance to come under pressure in the short-term. Our recommendation is underpinned by the following factors:
Taking into account the relatively low interest rate environment (currently CBR rate is at 7.0%) coupled with measures to ease repayment burdens on clients, we anticipate the group’s NIMs to be negatively affected in FY2020. Additionally, owing to the tough economic climate, we expect repayment challenges to affect income derived from NCBA’s M-Shwari in FY2020.
NCBA’s strength in digital lending is however, anticipated to support non-funded income growth in the long-term, after the COVID-19 pandemic. We opine there’s some regulatory risk (in Kenya) that could potentially result in lower fees charged on M-Shwari and Fuliza.
We also have some concerns about the group’s asset quality (the NPL ratio at the end of the 1Q2020 rose to 14.1% from 12.1% as at the end of FY2019 and this was attributable predominantly to legacy accounts (prior merger accounts). Given the nature of the group’s asset quality (legacy accounts, whose recoveries are quite slow) coupled with the high credit risk environment (brought on by the COVID-19 pandemic), we do not expect much improvement in asset quality in the short-term.
We are however optimistic that in the long-term the group’s diversified loan book – consisting of corporate (62.0%) retail (30.0%) and digital banking (8.0%) – to mitigate against the asset quality issue.
Going forward, we expect NCBA group to continue to focus on investing in government & investment securities (lending to the government) as well as lending in the inter-bank market in order to mitigate against the asset quality risks brought on by the COVID-19
pandemic. Consequently, we expect to see low loan book growth in 2H2020.
The group has adopted a 5 year growth strategy based on the following key priorities:
1) Scaling retail banking footprint
2) Deepening leadership in corporate banking and asset finance
3) Enhancing the digital experience for their customers
4) Developing a strong brand and
5) Fostering a high performance employee culture
We expect this strategy to be implemented effectively post-pandemic since, according to management, the group is focusing on surviving the pandemic. We are optimistic about the potential success of the merger. As at the end of 1Q2020, NCBA reported witnessing the
following synergies from the merger:
1) Revenue growth and commercial organization supported by:
i. enhanced cross-selling
ii. adoption of best in class sales practices and
iii. improved risk management
2) Greater potential to scale owing to:
iv. an alignment towards cost effective deposit raising
v. shift towards improved deposit mix and current account deposits
vi. improved access to capital markets due to scale
3) Operational optimization hinged on:
vii. branch optimization
viii. it integration and consolidation
ix. integration and optimization of support functions
x. consolidated procurement and facility management
1Q2020 Results Commentary:
NCBA Group realized after tax profits of KES 1.6 bn in 1Q2020.
The group’s profitability was underpinned by robust operating income which stood at KES 10.9 bn and improved operational efficiencies; the group’s cost-to-income ratio stood at 41.5% (lower than CBA’s 53.9% and NIC’s 47.6% in 1Q20219).
According to management, the group’s cost-to-income ratio largely benefitted from synergies unlocked from the merger (branch optimization, integration of support functions as well as IT integration and optimization).
The group’s customer deposits which grew by 3.2% q/q from KES 378.2 bn in FY2019 to KES 390.5 bn 1Q2020, was mostly channeled towards:
o Lending in the Interbank market: Cash and balances with central banks and commercial banks (+16.3% q/q to KES 73.0 bn) and
o Government and investment securities (+5.9% q/q to KES 154.7 bn)
NCBA’s loan book contracted by 1.4% q/q to KES 245.9 bn as the group adopted a cautious lending strategy amidst a slowdown in loan origination due to the COVID-19 pandemic.
Asset quality deteriorated further in 1Q2020; NPL ratio rose to 14.1% from 12.1% as at the end of FY2019 and this was attributable predominantly to legacy accounts (prior merger accounts).