Equity Group released Q1 21 results with EPS increasing by 63% yoy to KES2.29. The positive results were on the back of lower loan loss provision charge, higher non-interest revenue on increased fees and inclusion of the new BCDC acquisition (completed in H2 20). Overall, the Kenya unit's PAT increased by 86% yoy, showing strong organic growth in the bank’s earnings.
We retain Buy on Equity Group with a target price of KES46.00
The bank is trading at a current PB of 1.2x and a PE of 4.7x. Our recommendation is based on: 1) Strong regional performance, which now accounts for 23% of PBT as of Q1 21, with Congo, Uganda and Rwanda units delivering the highest returns. Management is keen on seeing this contribution rise to 40% in the medium term. 2) Strong non-interest revenue base driven by above-peer monetisation of digital channels and market-leading position in remittance transactions. 3) Strong market share position that drives cheap deposits and access to the wide SME market, which provides a strong base for loan book growth. 4) Continued efficiency, delivering sub-50% cost/income ratio, which we believe is sustainable.
Management outlook for 2021 turns positive
Management issued a revised outlook for 2021, which is more positive than before. Key changes include reducing the cost of risk outlook to 1.5-2.5% from 2.0-3.0% previously. Management considers its current coverage to be adequate and has minimal concerns on the economic outlook in 2021. The outlook for non-interest revenue contribution has been upgraded to 40-43% (from 38-43% previously) on the back of lifting the ban on digital banking fees and the increase in transaction volumes on digital channels. We agree with these two new changes, but remain sceptical of the rather aggressive loan book growth target of 20-25%.
Non-interest revenue up 30% yoy
This now contributes 42% to total income. Management noted that transaction fees on digital channels are still subdued, but that volumes remain strong with all mobile platforms recording 100%+ yoy growth in transaction values. Fee and commission income grew 22% yoy. In our view, the growth momentum in transaction volume is sustainable as the economy continues to support cashless transactions. FX income nearly doubled on increased foreign currency loan book and transactions.
Regional units contribute 23% of PBT with Congo driving growth
The key driver of growth was Congo, which now contributes 5% of PBT. This is mainly on the acquisition of BCDC in H2 20. Congo remains one of the most promising markets for the bank based on high margins and low banking penetration. Uganda and Rwanda with ROA of about 4% are now on Kenya's level. Management, however, still needs to scale the business in these two countries for regional contribution to match the 40% target. Tanzania remains a problem country with asset quality still straining profitability.
NPL ratio at 14.6% in Q1 21
Tanzania remains the problem country for the bank with the unit's NPL ratio at 33.7%. Management did not highlight the direction of asset quality in Tanzania but in our view, these loans should be written off considering the persistent weakness. Meanwhile, the micro enterprises and SME sector recorded NPL ratios of 10.1% and 15.5%, respectively with management now actively reducing exposure to the two sectors.
On restructured loans, the bank has about 31% of loans restructured with 19% of the loan book still under moratorium. We mentioned in our earlier report that the sector has been given until June to regularise loan classification. Management expects minimal NPLs to arise from this process. In terms of the main sectors accommodated, real estate, trade and transport take up 34%, 22% and 9% of the total loans, respectively. In our view, real estate remains the problem sector that the bank may not make a full recovery from. Management NPL target for 2021 is 7-10%.
On provision, the bank has provided 1%, 21% and 57% for their stage 1, stage 2 and stage 3 loans, respectively. The bank is still somewhat reliant on collateral to plug the gap on non-performing loans coverage and we reiterate our view that stage 3 loans coverage for the bank needs to be increased.
Net interest margin fell to 6.4% in Q1 21 – a temporary hiccup
Management attributed this to Congo where 60% of the balance sheet remains uninvested following the acquisition. Going forward, the bank expects to shift these to other interest-earning assets and hence anticipate a recovery on net interest margins.
A rising concern is the increasing allocation to corporate loans (now 21% of loan book) and foreign currency loans (now 41% of loan book), which may hamper the key advantage of Equity Group's ability to generate high loan yields from local currency SME and MSME loans. Even then, the SME book remains relatively large at 49% of total loan book. In our view, this may be management’s medium-term strategy to deal with the Covid-19 impact and low interest rate environment in which corporate entities have thrived compared with SME’s. In the long term, we believe the bank is likely to revert to SME lending as the bank retains its expertise in this segment.