Equity Group (Buy, TP: KES46.00) released FY 19 results with EPS rising by 14% yoy to KES5.93. This was 4% lower than the KES6.18 we expected. The underperformance was due to higher cost of risk at 1.3% versus our expected 0.8%. The bank's NPL ratio deteriorated, increasing significantly to 9.0% from 7.3% in FY 18, warranting the accelerated provisions made in Q4 19, which was much higher than the last three quarters. Weakness in the asset quality was mainly from the SME and agriculture segments, where the NPL ratio increased to 11.3% and 8.1% from 9.9% and 5.6% in Q3 19, respectively. Non-interest revenue grew 19% yoy to KES29.9bn from positive growth in mobile wallet and agency transactions. Equity Group has the most advanced alternative channel banking system among the banks we cover, and we believe the bank will continue to generate income from these channels. The bank declared a dividend of KES2.50, which was higher than we expected.
Equity Group is trading at a 2020f PB of 1.2x and PE of 5.9x. This is an attractive price point in our view, given the ROE of 21.9% in FY 19. Our concern for Equity Group is the continued plan for acquiring regional banks as there is risk of non-ROE accretive acquisitions being made.
- Management expects net interest margin to range between 8.5% and 9.5% in 2020. We expect the increase in net interest margin to be driven by the bank’s 85% SME and retail loan book, which is higher-yielding and has shorter-term loans.
- Management loan book growth target is 5-15% for 2020. Given the confirmation of the coronavirus cases in Kenya and the subsequent slow down of the economy, we see this as a reasonable target and expect most of this growth to have already occurred in Q1 20. Management targets deposit growth of 6-12%, which we believe is achievable based on the bank’s large retail market share.
- Management targets cost/income ratio to be between 49% and 52%.
- On asset quality, the NPL ratio is expected to be between 7.5-9.0%. We believe the bank will likely achieve the top-end of the target given the impact of Covid-19, locust infestation, real estate slowdown and the government not paying suppliers. The recent directive to extend the loan repayment period is likely to soften the impact of weakening asset quality in Q2 20 and Q3 20.
- We believe Equity Group is the least likely among Tier 1 banks to be impacted by the directive to cut fees on bank to mobile wallet transactions, as the bank is the least reliant on Safaricom for transactions.
- Non-funded income increased 19% yoy. Agency banking recorded a growth of 14% yoy in transaction value. On the mobile platform, although Equitel still accounts for the bulk of transactions, the bank’s mobile app is gaining significant traction especially with the SME cash management application, which recorded a 61% yoy increase in transaction value. Equity Group had a head start on adapting alternative channels, with clients now carrying out 79% of their transactions on mobile and internet banking. The bank generates the highest fees and commission income from these channels compared to local peers. We believe continued income growth will be delivered from product development and an increase in transaction volume.
- Robust balance sheet growth with loans growing by 23% yoy and deposits growing by 14% yoy. The bank’s liquidity remains high at 52.1% showing the capacity to grow its loan book further without much strain on funding costs. Net interest margin was 8.3% in FY 19 versus 8.5% in FY 18, with loan yields only shedding 10bps despite a cut in the central bank rate within the year. Loan yields in Q4 19 rose to 13.6% from 11.9% in Q3 19. We believe this came from lending to higher-yielding SMEs and retail loans, which accounts for 85% of its loan book.
- Cost/income ratio lowered to 51% in FY 19 from 52.4% in FY 18. Staff costs were up 12% yoy while other operating expenses grew 9% yoy. We expect the bank to continue spending on technology to accommodate higher transaction volumes and hire more tech-related staff.
- Significant asset quality weakness. NPL ratio rose to 9.0% from 8.3% in Q3 19. The main pressure points were SMEs and the agriculture loan book. Loan loss provision increased by 51% yoy with most of this booked in Q4 19. We believe this was tied to the fact that SME and agriculture loans typically do not have considerable collateral and hence the requirement for provision.
- Further loan book weakening from economic slowdown.
- Coronavirus headwinds.