In this report, we revisit the investment case for NMB. We upgrade our Hold recommendation to a Buy with our new target price of TZS4,780 (previously TZS2,440) suggesting an ETR of 118%.
At our target price, we are valuing the bank at 1.5x 2022f PB and 7.3x 2022f PE. At current price, the bank is trading at 0.7x 2022f PB and 3.5x 2022f PE. We see this as a fair valuation given the projected average ROE of 21.1% over our forecast horizon to FY 25f.
Our recommendation is based on:
The roll forward in our valuation model
Expected strong performance in fee and commission income (CAGR of 15% over our forecast period), which we believe will make up for the slight decline in net interest margin.
Efficiency will continue to improve with expansion now on the back burner and the key cost centred on technology spend. Even with the need to hire specialised staff to drive the bank's digital strategy, we expect staff costs to grow in line with inflation. We expect cost/income ratio to fall to 43.9% in FY 25f from 50.5% in FY 20.
Asset quality is set to remain below 5.0%, but with major write-offs completed and coverage level already high at 88.6% in FY 20, we expect cost of risk to average 2.0% over our forecast period.
Risks to our recommendation:
Regulatory risk.
Faster-than-expected turnaround of the wholesale unit.
Higher-than-expected write-offs in a bid to meet the 5.0% NPL ratio limit may result in higher-than-anticipated cost of risk.
Executive Summary
Of the two banks that we cover in Tanzania, we prefer NMB to CRDB. While we recognise the significant structural improvements that CRDB has made in the last decade (upgraded recently to a Buy), NMB still outperforms CRDB in the following aspects:
1. NMB commands higher margins due to large retail market share
NMB's margins have historically outperformed CRDB mainly because the bank traditionally had its lending in the salaried retail market. NMB's average loan yields for the last five years have therefore been higher at an average 15.3% compared to CRDB's 13.3%. While we expect a decline in net interest margin on account of lower loan yields driven by competition and regulation, NMB is set to retain its lead in net interest margin. We expect net interest margin to average 10.8% for NMB for the next five years compared to CRDB's 9.8.%.
2. NMB is more efficient and carries a lower cost/income ratio
NMB's cost/income ratio stood at 50.5% in FY 20 compared to CRDB's 59.8%. Although both banks pursued expansion strategies in the last decade, NMB was more prudent and ended up achieving branch profitability earlier than CRDB. Additionally, the bank rolled out digital banking earlier and more efficiently than CRDB, which led to higher efficiency. NMB is already well below the regulatory requirement for cost/income ratio set at 55% – we expect the bank's cost/income ratio to fall to 43.9% in FY 25 compared with CRDB's 51.0%. NMB's earlier investment in technology gives it a lead in fee and commission income and lower spending compared with CRDB, as well as higher branch profitability.
3. NMB has better risk management with higher asset quality and coverage
NMB's average NPL ratio for the last five years was 5.7% compared with CRDB’s 9.3%. The disparity in asset quality was on account of NMB's exposure to the personal lending segment where NPL ratio is usually below 2.0%. CRDB, on the other hand, was heavily exposed to the NPL-prone agriculture segment. While the two banks have now converged in terms of their strategy, NMB has been the more conservative lender and we are more confident in the bank’s ability to maintain its NPL ratio below 5.0% in line with regulations. Due to the bank's higher coverage, we expect cost of risk to remain below 2.0% even as coverage levels rise to an average 97%.
4. NMB has higher capital generation
Up until 2016, CRDB had to rely on external capital to beef up its capital position. This was done through a rights issue in 2015 and additional funds from subordinated debt and regulatory banking risk reserves. NMB on the other hand has been able to generate the larger portion of its capital needs from retained earnings throughout the past decade. NMB retains a higher capital adequacy than CRDB, which we believe will progressively see NMB's dividend pay-out ratio rise above CRDB's to 40% by FY 25.
Valuation
We value NMB using a two-stage dividend discount valuation methodology. We calculate an intrinsic value as per the methodology below.
Methodology
To calculate our fair-value estimate for NMB, we apply a two-stage dividend discount model using the profitability drivers discussed in various segments of this note, as well as a cost of equity (CoE) of 18% which we derive using a risk-free rate of 13%, an equity risk premium of 5% and a beta of 1.0x. Our valuation is in local currency, and we apply a terminal growth rate of 7%.
Our two-stage dividend discount model:
Stage 1: Standard five-year dividend discount model. Between FY 21 and FY 25, we estimate the present value of dividends using the profitability drivers discussed in this note.
Stage 2: We determine the terminal value as the perpetual growth rate in the bank's book value based on 2023's mid-cycle ROE of 20.9% and a terminal growth rate assumption of 7%.
Investment case
Digital channels set to continue driving fee and commission income
Relative to CRDB, NMB’s non-interest income is less diverse with an average 86% of non-interest revenue being derived from fee and commission income alone. Even then, the bank has managed to record a CAGR of 15% in fee and commission income in the last five years compared to CRDB’s 2% CAGR. For NMB, the main drivers of fee income have been mobile, ATM and loan fees which have recorded a CAGR of 54%, 10% and 16% respectively over the last five years. The bank rolled out digital channels much more efficiently than CRDB having used it to support its physical expansion strategy.
We project a CAGR growth of 15% in fee and commission income based on:
1. Strong loan book growth. We expect loan book growth to record a CAGR of 12%, which we believe will support loan fees. In FY 20, loan fees accounted for 25% of fee and commission income. We expect the loan book growth to be supported mainly by the retail segment in which NMB has a large market share.
2. Tanzania’s low financial inclusion levels, which we believe offers room to onboard new customers to the bank's platforms. 28% of Tanzania's adult population remain financially excluded, which is worse than its East African peers (although this may have improved slightly as the latest available data is from 2017).
One of the main challenges is Tanzania's vast size, which has meant low penetration of financial services. In 2019, Tanzania rolled out the national identity card project – the use of the national identity card to access civic services – with the the aim of improving traceability and transparency. At present, SIM card registrations are linked to the national identity card. The project is expected to enable financial institutions to access more customers.
In terms of reach, NMB's network expansion strategy has seen it grow its branch network by 29% since 2015 (compared with CRDB's 22%). The bank has, however, recently been keen on rolling out digital banking (alongside these branches), which shored up fee and commission income and lowered the cost of operating branches.
3. Digital channels, which account for 52% of fee income presently, set to continue growing strongly. Digital channels (cards, agency outlets, mobile banking and ATM outlets) account for 52% of fee income in FY 20 compared to 24% in FY 15. The key drivers of growth have been mobile banking and ATM outlets whose fee income CAGR over the last five years has been 54% and 10%, respectively.
In our view, three elements will continue to drive strong digital fee income: 1) increasing the client base as financial inclusion improves; 2) increasing the product suite of digital channels; and 3) continued adoption of digital channels as the formal transaction channel by both private and government institutions.
A potential threat to the bank's digital fee income remains the regulatory push for higher taxes. However, given that the government more than doubled taxes on mobile banking in 2021, we see minimal risk of further rises in the medium term.
Asset quality to remain better than peers
NMB has primarily had better asset quality relative to the industry. We expect the bank's NPL to average 4.0% over our forecast period, which is 100bps lower than the regulator’s limit of 5.0%. We expect this to be driven by the following factors:
1. NMB primarily lends to low-risk individuals. Due to NMB's higher level of lending to individuals (about 66% of loan book as of FY 20), the bank has maintained a better-than-peer average NPL ratio. About 80% of these loans are given to civil servants for whom deductions for repayments are made at source and hence maintaining very low NPL ratios relative to the sector. Management is keen on expanding lending to the manufacturing and the SME sectors as industrialisation picks up in the country. While the foray into the SME sector is likely to attract some weak assets, we do not expect NPL ratio to rise significantly as we expect management to be conservative in growing its SME book. We do not expect much change in the loan book structure and continue to expect lending to individuals to retain a larger share.
2. We expect continued write-offs to help clean up the wholesale sector loan book. The wholesale banking unit has been loss making for the last five years. The issues include:
Continued fall in asset yields in line with the overall fall in interest rates in the country. As of FY 20, the average asset yield for the wholesale segment was just 2.5% compared to the 13.5% asset yield on the retail loan book. As such, although there are opportunities opening in the market for lending with the improving business environment, we do not expect aggressive growth from the wholesale segment.
Weak asset quality resulting in high cost of risk. The wholesale unit accounted for, on average, 13% of NMB's total assets in the last five years, but accounted for an average 46% of the bank's loan loss provision charge within the same period. Under former president John Magufuli's disruptive leadership, the corporate segment endured a raft of policy changes that impacted corporate clients negatively. The clean-up of government suppliers' records and stall in their payments further slowed down business for the bank. While some of these problems may be a thing of the past now, we are cognisant that the damage done will take some time to be corrected. Lastly, corporate clients were impacted negatively by disruptions in global supply chains from Covid-19, even though the government itself did not sanction economically disruptive measures within the country. We expect the bank to continue cleaning up its wholesale book but expect write-offs as a percentage of NPLs to taper down to about 35% in FY 25 from the expected initial spike of 68% in FY 21. As such we expect cost of risk to average 2.0% over our forecast period given NMB already has high coverage levels.
3. Regulatory changes in 2018 allowed earlier write-offs and increased restructuring. In Q1 18, in a bid to get the industry NPL ratio down to 5.0%, the Bank of Tanzania introduced new regulations on how NPLs are handled, which have been positive for banks' asset quality:
Allowing banks to restructure loans up to four times, as opposed to two times previously. This enabled banks to delay the recognition of NPLs.
Giving banks permission to upgrade NPLs to performing status once the institution has received at least two consecutive payments from the borrower. This is down from four consecutive payments previously.
Requiring banks to write-off loans that have been non-performing for at least four quarters, instead of 12 quarters previously.
While these regulations primarily benefited CRDB, which reduced its NPL ratio to 4.4% in FY 20 from 13.8% in FY 17, NMB also saw a decline in NPL ratio to 5.0% in FY 20 from 6.4% in FY 17. We believe these regulations will aid the bank in sustaining a sub-5.0% NPL ratio.
4. President Samia Suluhu’s leadership has so far been positive for the economy. When former president Magufuli took over the leadership in 2015, banks were negatively impacted by rash decisions made to clean up the workings of the government. These decisions included laying off and removing allowances for civil servants, halting payments to suppliers as the government registers were 'cleaned up', and increasing tax bills from backdating the taxes owed by firms.
While these decisions were seemingly beneficial for the country in the long run, the uncoordinated and rushed decision-making process by the former president resulted in a significant rise in NPLs between 2016 and 2018. At present, even though current president Suluhu is still keen on similar reforms, her approach has involved stakeholders in the decision-making process and hence key changes are likely to be more staggered and less disruptive. President Suluhu has also taken the time to mend trade relationships regionally and improve international relations, which has opened up opportunities for Tanzanian firms. As such, we expect the stable macroeconomic environment to support asset quality going forward.
Pressure on net interest margin expected, but margins will still be higher than CRDB’s
The retail segment accounts for 66% of NMB's loan book as of FY 20 compared with 65% in FY 10. Going forward, we expect NMB's loan yields to fall in the coming years, compared to a rise in loan yields for CRDB, on account of increased competition and continued expansionary monetary policy pursued by the regulator. We don't expect much change in the loan-to-assets allocation for NMB and maintain it at 60% – just slightly higher than 58% in FY 20. CRDB on the other hand is coming off a low base in terms of loan-to-total assets allocation and we expect the bank to increase the allocation of loans-to-assets from 54% in FY 20 to 60% in FY 25, which we believe will offer some margin protection. Despite this, we still expect NMB's margins to remain higher than CRDB's on account of its dominance in the retail market. We expect net interest margin to average 10.8% for NMB for the next five years compared with CRDB's 9.8.%.
Risks to our recommendation:
Regulatory risk: In the recent past, the government and the regulator have both come up with policies that significantly impacted the banking sector. Of note, the government is currently keen on lowering overall interest rates in the market. While we believe a rate cap is unlikely, banks are not entirely out of the woods yet, particularly in terms of regulations that may impact loan yields. As mentioned earlier, digital transactions remain a soft target for taxation. In our view though, given the more-than-doubled tax rates in 2021, we believe it is unlikely for higher taxes to be imposed. Overall, however, the Bank of Tanzania seems to be keen on managing the sector via regulations as opposed to primarily providing oversight, which is a concern.
Faster-than-expected turnaround of the wholesale unit.
Higher-than-expected write-offs in a bid to meet the 5.0% NPL ratio limit may result in higher-than-anticipated cost of risk. In our forecasts, we have assumed lower than historical write-off levels with the assumption that the bank has completed the major loan book clean-up that began in 2018. In the event that there are higher write-offs, cost of risk may be higher than expected, thereby reducing earnings.
Tanzania Macroeconomic update
Following the death of the former president, John Magufuli, in March 2021, Tanzania has moved in a new direction under the leadership of President Samia Suluhu. The country is now reporting Covid-19 cases and has initiated vaccination, with about 1.5% of the population being fully vaccinated. This was a key demand required by the IMF to secure further funding from the institution. Though the extent of the Covid impact is difficult to assess, GDP growth recorded a slowdown to 4.8% yoy in 2020 from 7.0% yoy growth in 2019. So far, the new government has not been keen to implement stringent measures that would impact the economy negatively. The World Bank estimates GDP growth will remain above 5.0% until 2026.
Tanzania’s inflation rate remains below 5.0%, with the only major concern being rising food prices. Even then, this is being offset by lower rent, transport and cooking fuel prices. The government updated the inflation methodology in Q1 21 with the new base year being 2020, which is more reflective of accurate inflation and overall price measures over the medium term. The World Bank estimates inflation will remain below 4.0% in the medium term, which we expect to offer economic support.
Both the current account deficit and fiscal deficit remain low compared to East African peers, at 1.8% and 1.1% in 2020 respectively. Relative to East Africa peers, Tanzania possesses a lower debt burden, potential higher revenue growth rates (though this comes off a low base) and higher development spending, presenting an opportunity for the country to be an exciting investment destination for the region.
Suluhu’s government has focused on reform measures for trade and infrastructure, which so far have marked a move away from Magufuli’s erratic, authoritarian and non-business-friendly policies. Though the damage done under Magufuli’s rule will not be undone overnight, President Samia Suluhu is on the right track in steering Tanzania towards mending trade relationships, kick-starting infrastructure and encouraging trade with global entities.
With Tanzania’s economic outlook now turning in a positive direction and plenty of headroom for growth, we believe this will offer CRDB a launchpad for its next phase of growth.
