Market Report – 26th March 2021

Market Commentary:

• The All Share Index and NSE 20 Share Index eased by 0.3% and 1.6% w/w to close the week at 166.48 and 1,903.06 respectively. This was characterized with by price declines on majority of the counters. Overall market turnover increased by 42.1% to KES 2.4 billion as the volume of shares traded increased by 42.9% to 82.4 million shares.
• Safaricom edged up marginally (+0.4% w/w) to close at KES 38.75. The banking and insurance sectors saw overall selling pressure as supply outweighed demand. We attribute this to a number of factors including profit taking on companies whose prices had rallied in recent weeks and dismal expectations of FY2020 financial results. Notably, DTB (-9.8% to KES 66.50). NCBA (-7.4% to KES 23.10), Liberty (-6.4% to KES 8.20), Jubilee (-6.1% to KES 267.75) and Absa (-6.1% to KES 8.86) emerged in the week’s top 5 losers.
• In the coming week, we expect increased selling pressure on the back of stricter COVID-19 containment measures announced by the president. The measures target counties that have had a surge in positive cases. The targeted counties are Nairobi, Kajiado, Machakos, Kiambu and Nakuru. Some of the measures include movement restrictions in and out of the aforementioned counties (as one zone), a suspension of physical learning (countrywide) and public gatherings and a new commencement time for the curfew (start at 8:00 PM instead of 10:00 PM). More details can be found here.
• We believe this will have a positive impact in containing the rise in positive cases. We however expect a negative economic impact with an immediate hit to the tourism, transport and hospitality industries (that were gradually recovering), and a trickledown effect to other sectors such as banking (rise in non-performing loans, more cautious lending etc.).

News Highlights:

Absa Kenya Posts a 44.2% y/y decline in After Tax Profits for FY2020

• Absa Kenya posted a 44.2% y/y decline in after tax profits for FY2020 to KES 4.2 billion (FY2019: KES 7.5 billion). The dip in profitability was predominantly due to increased loan loss provisions.
• Total interest income rose by 1.3% y/y to KES 31.4 billion. This was mainly driven by a 10.7% y/y increase in interest income from government securities to KES 9.0 billion as holdings of government securities increased by 2.5% y/y to KES 126.1 billion. The yield on government securities declined to 10.6% (FY2019: 11.4%).
• Interest income from loans and advances dipped by 1.1% y/y to KES 22.3 billion. This was despite the loan book growing by 7.2% y/y to KES 208.9 billion. We attribute the decline to lower yields on loans – fell to 10.2% (FY2019: 11.4%). The decline in the yields was attributed to the low Central Bank Rate (CBR) of 7.0 % as some of the loans are still pegged on the CBR + 4.0% regime. The bank is still waiting for approval for its risk based pricing model.
• Total interest expenses rose by 2.7% y/y to KES 8.1 billion (FY2019: KES 7.9 billion).
• Interest expenses from customer deposits decreased by 7.3 % y/y to KES 6.0 billion supported by the easing of cost of customer deposits to 2.5% (FY2019: 2.9%). Customer deposits increased by 6.7% y/y to KES 253.6 billion. The bank continues to focus on cheaper deposits.
• However, the dip in interest expenses from customer deposits was offset by 51.2% y/y increase in interest expenses from deposits and placements from banking institutions to KES 1.9 billion.
• Net interest income increased slightly by 0.9% y/y to KES 23.4 billion. The net interest margin eased to 7.8% from (FY2019: 8.4%) as interest earning assets grew at a faster rate (+9.5% y/y to KES 304.2 billion) than net interest income (+0.9% y/y to KES 23.4 billion). The slower growth in net interest income was partly due to the lower asset yields.
• Non-funded income (NFI) grew by 5.2% y/y to KES 11.1 billion primarily due to 22.2% y/y rise in foreign exchange trading income to KES 4.5 billion. Fees and commissions on loans and advances dipped by 10.8% y/y to KES 1.3 billion. Other fees and commissions declined by 9.6% y/y to KES 4.3 billion. The contribution of NFI to total income improved to 32.3% (FY2019: 31.4%). We note that the increase in contribution may have been owing to the slower growth in net interest income.
• Operating expenses (excluding provisions) declined by 3.7% y/y to KES 16.7 billion (FY2019: KES 17.5 billion) mainly due to a 3.9% y/y decrease in staff costs to KES 9.8 billion and a 3.3% y/y dip in other expenses to KES 5.2 billion. As a result, the cost to income(C/I) ratio (excluding provisions) fell to 48.2% (FY2019: 51.2%)
• Loan loss provisions surged by 114.9% y/y to KES 9.0 billion as gross non-performing loans grew by 26.5% y/y to KES 17.1 billion, with 30.0% of the loan book (KES 62.0 billion) restructured due to Covid-19. Consequently, the NPL ratio grew to 16.0% (FY2019: 14.0%). According to management, currently only KES 3.0 billion of the restructured loans are left in payment holidays with the remainder back on stream as normal loans.
• The bank withheld dividend for FY2020. According to management, the move was aimed at capital preservation for CAPEX investments as the bank sees growth opportunities ahead particularly in projects such as diaspora remittances, online business banking etc. Management also noted the economic uncertainty brought on by the third wave.

Commentary:

• We are optimistic about:
• Improvement in cost to income ratio: The bank has consistent improved the cost-to-income ratio (excluding provisions) over the past three years from 56.0% in FY2018 to 48.0% in FY2020. We expect the bank to continue focusing on operational efficiency.
• Turnaround in the deposit growth: In the 4Q2020, the bank registered growth in deposits from a declining positon in the previous quarter.
• Lower cost of funds: The focus on cheap deposits is also a positive for the bank.

We expect all of these to continue supporting growth for the bank during and after COVID-19.

• On the pandemic related events,

In our view, the aggressive provisioning (bulk of the provisions were on performing loans) and withholding of the FY2020 dividend was the right move. The country is dealing with a third wave of the COVID-19 and a raft of new stringent containment measures have been implemented. This should negatively impact the economy in the short to medium term. Adopting a conservative outlook and increasing the capital buffers (by withholding dividends) should benefit the bank.

• We expect the bank to continue transforming the business model with focus on digitization, innovation and business diversification.
• Our recommendation on the counter is under review.

ILAM Fahari I-REIT Posts 15.5% y/y Decline in Profits for FY2020

• ILAM Fahari (formerly Stanlib Fahari) I-REIT reported a 15.5% y/y decline in profits for FY2020 to KES 175.2 million (FY2019: KES 148.0 million).
• The decrease was primarily due to an 8.3% y/y dip in revenue to KES 324.7 million as well as a dip in fair value adjustment to investment property by 272.8% y/y to KES 13.6 million.
• The decline in revenue was mainly owing to a 272.8% plunge in the straight-lining of lease income to a loss of KES 16.5 million. Rental and related income also eased by 0.9% y/y to KES 341.2 million as tenants adversely affected by the pandemic were given rental concessions.
• Other income decreased by 9.7% y/y to KES 22.9 million. This was owing to a 10.3% y/y decline in interest income to KES 22.4 million which offset the 41.7% y/y (to KES 464,000) rise in sundry income. The decline in interest income was attributed to scaling down of investments in t-bills (to nil), as the rates were seen to be not as attractive as the fixed and call deposits (+7.2% return).We note that the environment was generally characterized by lower interest rates(hence returns on fixed and call deposits were not able to offset the decline)
• Operating expenses grew 1.8% y/y to KES 229.6 million predominantly due to a surge in bad debts provisioning to KES 33.2 million (FY2019: KES 122,941).
• The significant increase in bad debt provisioning was attributed to the non-performance of the anchor tenant at Greenspan Mall (Tuskys, which occupies 48.0% of the mall and currently has 86.0% occupancy). The mall is currently the largest property for the REIT.
• Management is expecting a new anchor tenant with a 10 year lease at Greenspan Mall to replace Tuskys. We opine that this will boost revenues. The Kenyan retail space (supermarkets in particular) has been faced with challenges leading to exits in retail spaces (examples Nakumatt, Uchumi, Tuskys). We see a need to diversify away from this space. The new tenant will be disclosed by end of March 2021.
• The I-REIT currently owns four properties (the shopping center (Greenspan mall), an office building and two semi-office/ light industrial buildings). The 67 Gitanga Place (office building) and Bay Holdings (semi-office/light industrial) have 100.0% occupancy while the Signature (semi-office/light industrial) property still vacant.
• Property expenses fell by 14.9% y/y to KE 97.2 million. Fund operating expenses fell by 10.8% y/y to KES 99.3 million. The dip in fund operating expenses was attributed to the I-REIT Manager temporarily reducing fees by 10.0% to cushion the investors.
• Excluding the bad debts provision, operating expenses declined by 12.9% y/y to KES 196.5 million.
• Increase in fair value of investment property edged up by 39.0% y/y to KES 30.1 million. This was driven by improvement in the straight-lining of lease income by >100.0% y/y to KES 16.5 million from a loss of KES 9.5 million. Fair value adjustment to investment property however eased to 272.8% y/y t KES 13.6 million. The decline was attributed to valuation uncertainty due to the COVID-19 pandemic.
• According to management, tax leakages at the subsidiary level continued to dampen the performance during the year with KES 13.9 million (FY2019: KES 16.5 million) provided against irrecoverable withholding taxes. The subsidiary tax legislation is expected to be completed in 2021 (publication slowed down by the pandemic). This is expected to curb the leakages in FY2021 as it will pave way for issuance of tax exemption certificates to the REIT subsidiaries.
• Cash and cash equivalents grew by 105.9% y/y to KES 197.8 million as cash generated from operations edged up by 39.0% y/y to KES 160.4 million (FY2019: KES 115.4 million) and cash inflow from investing activities rose to KES 77.1 million (FY2019: -186.4 million)
• A dividend of KES 0.60 has been recommended (FY2019: KES 0.75)-subject to shareholder approval at the annual general meeting scheduled for 16 April 2021.

Commentary:

• We note with concern the decline in revenue.
  • The pandemic has seen less traffic to some of the businesses in malls such as pubs, restaurants and cinemas and less spend time, which has a direct impact on the company’s revenues (rent concessions on tenants).
  • Rental yields in the real estate sector had taken a hit prior to the pandemic (since 2016) owing to oversupply and duplication in the real estate sector. We expect weakening in rental income to continue as the Covid-19 pandemic persists.
  • We expect the office space in particular to remain subdued as the economy remains relatively weak in the short to medium term. We opine that the pandemic may result in a long-term shift whereby companies may not see the need for large working spaces.
  • Although the industrial property space has seen increased demand (need for storage facilities due to supply chain disruptions), overall, there remains uncertainty in the real estate sector owing to the pandemic. We note that modern warehouses could be a good diversification investment for the REIT as e-commerce gains traction.
• A new strategy is set to be issued by the REIT. The company is open to adding more property with the sectors yet to be determined. We opine that increased diversification in investments would be needed to strengthen the top and bottom-line performance.
• The unit price (KES 6.94 as at 26^th March 2021) is still significantly lower than the net asset value per unit of KES 20.86 as at FY2020. This was attributed to, among other things, investor awareness and sentiments as well as concerns on the property market. We opine that improvement in the underlying performance would improve investor sentiment on the I-REIT and close this gap.
• The I-REIT maintained its dividend payout of 80.0% on distributable earnings despite the revenue decline. We are NEUTRAL on the IREIT.

Recommendations: Under Review