We initiate coverage on Bank AlJazira (BJAZ) with a Neutral rating and a PT of SAR17.1. BJAZ’s enhanced capitalisation is a material positive, which would allow the bank to improve the utilisation of its existing franchise. Nonetheless, we expect post zakat ROEs (12.4% by 2023f from 7.9% in 2019f) to remain below those of the peer group, given the bank’s elevated cost base. Cost of risk is also expected to remain high, due to higher Stage 2 loans. Hence, BJAZ trading at 2019f PB of 1.1x, a discount to the peer group average PB 1.9x (42% discount vs last 3 years avg of 49%).
Increased capital to unlock value in retail franchise: BJAZ has a strong footprint in the retail segment, translating into one of the highest yields on earning assets. The bank also has a commanding position in the remittance and brokerage business, which account for 20% and 12% of fee income, respectively. Nonetheless, underutilisation of assets remains the biggest weakness for the bank resulting in one of the lowest ROA in the sector. LDR of 72% is among the lowest in the sector (80% industry average), and is funded by expensive time deposits and debt funding. However, we believe this is set to change as the bank has substantially improved its capital base after last year’s right issue. This would allow the bank to aggressively expand its loan book, both in the corporate as well as retail segments. We expect the bank’s loan book to record a CAGR of 12.6% in the next five years.
Weak earnings outlook: BJAZ is one of the smallest Saudi banks with total assets of SAR74bn. The bank suffers from low structural profitability given its small scale. We believe operating costs are likely to remain elevated as the bank prioritises loan book growth over cost rationalisation. An expected improvement in the cost to income ratio from 59.8% in 2018 to 46.8% by 2023f is largely a function of a growing revenue base. The bank also has high Stage 2 loans and relatively low coverage of Stage 3 loans. Therefore, we expect cost of risk to remain elevated in the 50-80bps range during 2019-23f vs 30 bps in 2018. Overall, we expect post-Zakat ROEs to improve from 7.9% in 2019f to 12.4% by 2023f, still below the peer group average.
Discounted valuation justified: The stock is trading at a 2019f PB of 1.1x vs the peer group average of 1.9x, which we believe is justified given lower ROEs. Also, increased earnings would not directly translate into a higher dividend payout given management’s focus on growth. We forecast the stock dividend yield to stay around 3.0-4.0% during 2019-23f.