Equity Analysis /
Kenya

Equity Group: Asset quality weakness persists; Upgrade to Buy on valuation

    Faith Mwangi
    Faith Mwangi

    Equity Research Analyst, Financials (East Africa)

    Tellimer Research
    24 May 2019
    Published by

    Equity Group Q1 19 EPS rose by 4.9% yoy, to KES1.63, 6% weaker than our expectations, with the key surprise being weak asset quality. The NPL ratio stood at 9.0% versus Q1 18’s 6.3%, which management attributed to its Tanzania unit. In our view, Tanzania asset quality is unlikely to improve. We are likely to see some volatility in NPL numbers this year as Tanzania allows for NPLs to be re-classified to performing within just two months of repayment. Meanwhile, earnings before provisions rose by 7% yoy, despite a weaker net interest margin. Q1 ROE was 26%, versus our estimate of 27.5%

    We upgrade Equity Group to Buy from Hold on recent price weakness. Our TP remains KES46 (ETR 31%). Equity Group trades at 2019f PB of 1.3x and PE of 6.0x. In our universe, Equity Group retains a head start in technology adaptation and in mobile banking, which leads to higher-than-sector fee-driven non-interest revenue. The bank’s new partnership with Safaricom should give Equity Group access to a wider set of clients and the capacity to create M-Pesa-backed products, but we expect the bottom line impact to be marginal. Among Kenyan banks, KCB is our top pick.

    Asset quality disappoints, with the NPL ratio rising to 9.0% from 6.3% in Q1 18 and 7.6% in Q4 18. The key strain was in Tanzania, where the NPL ratio rose to 31.6% from 25.7% in Q4 18. Kenya’s NPL ratio rose to 8.5% from 7.2% in Q4 18. For Tanzania, we may see much lower NPL numbers towards end-19 as regulations require NPLs older than one year to be written off. Also, once a loan has performed for two months, it can be re-classified. However, we have seen minimal improvement in the economic environment, which is bad news for improved recoveries. In Kenya, asset quality is set to remain weak given the current drought and continued strain in the trade segment, where the bank has SME clients. 

    Loans and deposits grew by 13% yoy and 11% yoy, respectively. Management noted that the bank will revert to lending this year, given the falling interest rates on government securities. The net interest margin fell by 30bps qoq due to lower investment earnings. We expect the investment shift to keep the net interest margin at 8.2% in 2019.