Buy Zenith Bank shares, Hold ZENITH 2022 bonds: We think it may be worth taking another look at Zenith Bank stock. We recently downgraded our recommendation on the ZENITH 7.375% 2022 bond to Hold from Buy. As stated at the time of the downgrade, the change reflects the bond’s performance. Zenith Bank’s fundamentals remain best-in-class and we expect profitability and other metrics to continue to compare well to peers. We have maintained a Buy recommendation on Zenith Bank equity, our top pick among Nigerian bank stocks. Our target price of NGN40.00 implies an estimated total return of more than 150% – we think the share price will more than double.
Great year for bonds, challenging year for equities: The ZENITH 2022 bond is now quoted over 100bps tighter than at the start of the year and yields c5%. Positive technicals have driven this performance – Nigerian banks have redeemed US$1.8bn in eurobonds this year, none of which have been replaced. As a result, all bank bonds are much tighter than at the start of the year. In stark contrast to the performance in the bond market, Nigerian bank equities are down 20% since the start of 2019. Zenith Bank stock is down 18% YTD. The Nigerian stock market has fared worse than a number of other frontier and emerging markets this year, as concerns about the outlook for growth have weighed on valuations.
Considering other markets – Akbank vs. Zenith: We think it is worth comparing Nigerian banks to their larger Turkish counterparts, given the impact of challenges in Turkey on ratings as well as other factors, such as profitability and dividend payments. The ZENITH 2022 security started the year almost 70bps wider than the AKBNK 2022 bond, but is now quoted more than 120bps tighter. In the equity market, Akbank’s P/E ratio of 6.6x compares with Zenith Bank’s 3.1x. At the start of the year, these multiples were 4.6x (Akbank) and 3.9x (Zenith Bank). Based on total assets, Akbank is about 4x the size of Zenith Bank. In addition, Akbank’s cost/income ratio is much lower than at Zenith Bank and so is the NPL ratio. However, Zenith Bank is much more profitable, and reported higher capital and coverage ratios. Both banks’ senior bonds are rated B2 at Moody’s and B+ at Fitch, but Zenith Bank’s ratings carry stable outlooks while Akbank’s remain on negative outlook.
Risks to our view: Strong fundamentals notwithstanding, concerns about the outlook for economic growth may continue to weigh on Zenith Bank equity valuations. In addition, regulatory changes which have generated headlines may also impact performance, though we note comments from Zenith Bank management that in seeking to meet minimum LDR requirement, the lender will not compromise on asset quality. Finally, there is a risk of some volatility in Zenith Bank’s trading income line. We expect this revenue stream to moderate over the medium term. This may weigh on performance and valuations.