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KCB Group Stock Rating Target Price Closing Price Buy KES62.8 KES37.6

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KCB Group Stock Rating Target Price Closing Price Buy KES62.8 KES37.6 27 November 2020 KCB Group Stock Rating Target Price Closing Price Buy KES62.8 KES37.6 Equity the beneficiary as KCB chases yet more What's Changed From To underproductive assets Company Update Banks. Kenya Rating: $RECO $ Target Price $ISO $$TP$ Potential acquisition of ABC Tanzania and BRP Rwanda KCB Group’s press release yesterday morning indicates that the bank is in discussions with the Atlas Mara Group to potentially acquire: i) a 62.06% stake in Banque Populaire Du Rwanda (BPR); and ii) a 96.6% stake in African Banking Corporation Tanzania Limited (ABCT). In addition, assuming that the BPR deal is successful, the bank intends to acquire the minority shareholders’ stake (37.94%) at the same acquisition multiple. Based on our calculations, we estimate the size of the transaction could be c.KES3.5bn-KES5.5bn (depending on whether the bank will be able to acquire BRP’s minority shareholders’ stake). We believe this will be another poor acquisition, if completed After sinking in KES6.2bn to acquire NBK (NPL ratio of +50%, CAR of 10.3%, and negligible ROE as of 9M20) less than twelve months ago, we think this could be yet another poor transaction by KCB, as: i) the inorganic growth as a result of the acquisition (+4.4% increase in loans and +6.7% increase in deposits) is not sufficient to offset the subsequent management distraction, especially as this growth could have been achieved organically (KCB Group’s 9M20 loans and deposits are up 7.9% and 12.5% YTD, respectively); ii) the underlying assets have low profitability, in both absolute (ABCT and BRP had FY19 ROEs of -24.3% and 8.1%) and relative terms (KCB Group had an ROE of 20.7%) – we think these assets could be a drag on group profitability in the medium term due to the modest market share in Tanzania and combination of legacy assets and increasing competition in Rwanda; and iii) despite the overall potential impact on KCB Group’s CAR being modest (c.-80bps), we think the overall cost is higher due to the underlying opportunity cost of not deploying the capital in more profitable ventures (like KCB Kenya, which reported a FY19 ROE of 23.8%) and as it is a further management distraction. Current valuations imply limited downside, but upside will be curtailed as well – a win for Equity We have not adjusted our estimates after the announcement as we await further information from management. Despite our negative view on the transaction, we maintain our Buy rating on the bank as its valuation remains attractive (FY21e P/E of 0.8x) and given the limited impact that the potential transactions would have on KCB’s overall fundamentals (and potentially absorbed by a strong bounce back in earnings next year). While the potential downside is limited, in our view, we also think the increased drag and lower visibility of earnings may prevent its valuation achieving its fair value. Therefore, we make Equity Bank our top bank pick in Kenya, due to: i) greater visibility on its earnings trajectory; ii) a more defined strategy; and iii) better management of underlying asset quality issues post COVID-19. Key Financial Highlights (Dec Year End) Stock Data Closing Price KES37.6 as of 25 Nov 2020 H2,BH1,BWH1,CBH9 In KESmn, unless otherwise stated 2019a 2020e 2021e 2022e Last Div. / Ex. Date KES2.50 / 27 Apr 2020 Mkt. Cap / Shares (mn) USD1,100 / 3,213 Total banking income 84,301 90,091 103,444 114,094 Av. Daily Liquidity (mn) USD0.43 Operating income 45,786 46,884 59,536 65,436 52-Week High / Low KES55.0 / KES30.6 Net income 25,165 15,155 31,306 35,934 Bloomberg / Reuters KNCB KN / KCB.NR EPS (KES) 7.83 4.72 9.74 11.18 Est. Free Float 73.1% EPS consensus (KES) 7.83 N/A N/A N/A Price to earnings 4.8x 8.0x 3.9x 3.4x Dividend yield 9.2% 5.3% 9.3% 11.3% Ronak Gadhia, CFA Price to book value (tangible) 1.0x 1.0x 0.8x 0.7x +44 2075182905 | [email protected] ROAE (tangible) 21.5% 12.1% 22.5% 22.0% Capital adequacy ratio 16.9% 16.7% 17.1% 17.5% Kato Mukuru +971 4 364 1904 | kmukuru@efg -hermes.com H2,BH1,BWH1,CBH9NPL coverage 72.1% 69.2% 78.0% 77.3% Source: KCB Group, Bloomberg and EFG Hermes estimates Disclosure Appendix at the back of this report contains important disclosures, analyst certifications Page 1 of 12 and the status of non-US analysts KCB Group 27 November 2020 Banks. Kenya Data Miner Investment Thesis Valuation and Risks KCB Group is a financial services company based in Kenya with Our TP for KCB is KES62.8. At this price, we value the bank at subsidiary operations in Uganda, Tanzania, Rwanda, Burundi, 1.3x its twelve-month rolling forward BVPS. We derive this and South Sudan. The group provides a range of financial valuation using our standard dividend discount model using a services including Commercial and Investment Banking and cost of equity estimate and terminal growth rate for Kenya of Bancsassurance. We estimate its EPS to fall 39.8% Y-o-Y in 16.5% and 8%, respectively. The key upside risks to our target FY20e due to: i) a surge in its cost of risk as a result of the price are: i) higher-than-expected margin expansion; ii) stronger- impact from COVID-19; ii) lower margins on the back of a than-expected loan growth; and iii) lower-than-expected cost of reduction in MPR; iii) lower fee income due to a reduction in risk from FY21e onwards due to a better-than-expected recovery digital loan volumes, and iv) higher cost base as it would have from the impact caused by the COVID-19 pandemic. On the consolidated NBK for a full twelve-month period. However, we downside, we think our TP could be impacted by: i) higher-than- expect its EPS to more than double in FY21e onwards and expected increase in NPLs due to the impact of COVID-19; ii) increase at a CAGR of 10.5% over FY21-24e, due to: i) margin lower-than-expected NIM expansion and loan growth following expansion following the approval of its risk pricing model; ii) the repeal of rate caps; and iii) poor execution of cost reduction acceleration in NIR due to increased digital loan volumes; iii) cost strategies at NBK. savings from NBK; and iv) normalisation of risk charge as the impact of COVID-19 recedes. Overall, despite the ST earnings pressure, we estimate its ROE will revert back to its normalised range of 21-22% from FY21 and we therefore remain positive on the bank. Dec Year End Dec Year End In KESmn, unless otherwise In KESmn, unless otherwise 2019a 2020e 2021e 2022e 2019a 2020e 2021e 2022e stated stated Income Statement Valuation Metrics Net interest income 56,130 62,401 71,438 82,393 Price to earnings 4.8x 8.0x 3.9x 3.4x Non interest income 28,171 27,690 32,006 31,702 Price to pre-provision earnings 2.6x 2.6x 2.0x 1.8x Total banking income 84,301 90,091 103,444 114,094 Price to book value 0.9x 0.9x 0.8x 0.7x Operating expenses (38,515) (43,207) (43,908) (48,659) Price to book value (tangible) 1.0x 1.0x 0.8x 0.7x Operating income 45,786 46,884 59,536 65,436 Dividend yield 9.2% 5.3% 9.3% 11.3% Total provisions (8,889) (24,265) (16,356) (14,101) ROAA 3.1% 1.6% 3.0% 3.1% Other income / (expense) 0 0 0 0 ROAE 20.7% 11.5% 21.4% 21.0% Income before taxes or zakat 36,897 22,620 43,180 51,335 ROAE (tangible) 21.5% 12.1% 22.5% 22.0% Taxes or zakat (11,732) (7,464) (11,875) (15,400) Leverage (Assets / Equity) 6.6x 7.2x 7.2x 6.9x Minorities & other items 0 0 0 0 KPIs Net income 25,165 15,155 31,306 35,934 Loan growth (Y-o-Y) 17.4% 5.8% 10.1% 10.4% Balance Sheet - Key Highlights Loans / Deposits 78.0% 72.6% 71.5% 70.7% Customer loans 535,371 566,594 623,556 688,450 Banking income growth (Y-o-Y) 17.4% 6.9% 14.8% 10.3% Total interest earning assets 813,022 902,198 1,008,337 1,126,880 Operating income growth (Y-o-Y) 24.4% 2.4% 27.0% 9.9% Risk-weighted assets 644,498 696,704 776,132 866,458 Earnings growth (Y-o-Y) 4.9% -39.8% 106.6% 14.8% Total assets 898,572 995,291 1,108,760 1,237,797 Net interest spread 7.32% 7.02% 7.21% 7.42% Customer deposits 686,583 780,474 871,531 973,208 Non-interest income / Banking inc. 33.4% 30.7% 30.9% 27.8% Total interest bearing liabilities 728,439 819,082 905,545 1,007,669 Cost-to-income 45.7% 48.0% 42.4% 42.6% Common shareholders' equity 129,741 133,797 158,682 183,369 NPL ratio 10.9% 15.0% 10.0% 8.0% Per Share Numbers NPL coverage 72.1% 69.2% 78.0% 77.3% EPS (KES) 7.83 4.72 9.74 11.18 Cost of risk (bps) 168.1 400.0 250.0 200.0 DPS (KES) 3.45 2.00 3.50 4.25 Tier 1 ratio 15.0% 14.9% 15.6% 16.1% BVPS (KES) 40.4 41.6 49.4 57.1 Capital adequacy ratio 16.9% 16.7% 17.1% 17.5% BVPS (tangible) (KES) 38.4 39.5 47.0 54.4 Source: KCB Group, EFG Hermes estimates Source: KCB Group, EFG Hermes estimates Page 2 of 12 KCB Group 27 November 2020 Banks.
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