Valuation Summary

• We are of the view that Equity Group is a “BUY” with a target price of Kshs 55.3, representing an upside of 56.9%, from the current price of Kshs 35.25 as of 29th May 2020,
• Equity Group is currently trading at a P/TBV of 1.3x and a P/E of 6.2x vs an industry average of 1.0x and 5.4x, respectively.

Key Highlights Q1’2020

• Equity Group recently restructured loans amounting to Kshs 92.0 bn equivalent to 25.1% of its net loans, which stood at Kshs 366.4 bn in FY’2019 due to the Coronavirus related hardships affecting its customers.
• The bank was given the green light by the Committee Responsible for Initial Determination (CID), a Commission mandated to monitor and investigate possible breaches of the COMESA Competition Regulations, to acquire a 66.5% controlling stake in Banque Commerciale du Congo (BCDC),
• The bank’s board of directors announced that it was changing its earlier recommendation of paying a first and final dividend of Kshs 2.5 per share for FY’2019, and instead, recommend to the shareholders that no dividends be paid for FY’2019. This decision was made considering the effects of the COVID-19 pandemic and the need to conserve cash to enable the company to respond appropriately to the unfolding crisis in terms of supporting its customers through the crisis and directing cash resources to potential opportunities that may arise as economies in which the group operates begin to recover.

Income Statement

• Core earnings per share declined by 14.1% to Kshs 1.41, from Kshs 1.64 in Q1’2019, worse than our projections of a 2.0% decline to Kshs 1.61. The performance was driven by a 46.4% increase in total operating expenses, which grew faster than the 12.7% growth recorded in total operating income. The variance in core earnings per share growth against our expectations was largely due to the 660.4% rise in Loan Loss Provisions (LLPs) to Kshs 3.1 bn, from Kshs 0.3 bn in Q1’2019, which was higher than our expectation of a 129.7% increase to Kshs 0.9 bn. The increased provisions is attributed to the bank adopting a cautious stance on the back of the expected impact of the COVID-19 pandemic,
• Total operating income rose by 12.7% to Kshs 19.9 bn, from Kshs 17.6 bn in Q1’2019. This was driven by a 15.8% rise in Non-Funded Income (NFI) to Kshs 8.3 bn, from Kshs 7.2 bn in Q1’2019, coupled with a 10.6% increase in Net Interest Income (NII) to Kshs 11.5 bn, from Kshs 10.4 bn in Q1’2019,
• Interest income rose by 14.3% to Kshs 15.4 bn, from Kshs 13.5 bn in Q1’2019. This was driven by an 18.7% increase in interest income on loans and advances to Kshs 10.8 bn, from Kshs 9.1 bn in Q1’2019, coupled with a 9.0% increase in interest income on government securities to Kshs 4.5 bn, from Kshs 4.1 bn in Q1’2019. The growth in interest income was however weighed down by a 55.1% decline in interest income from placements to Kshs 0.1 bn, from Kshs 0.3 bn in Q1’2020. The slightly stronger growth in interest income on loans as compared to interest from government securities is indicative of the benefits accruing to Equity Group Holding’s strategy to increase lending to the private sector, focusing on Small and Medium Enterprises. The yield on interest-earning assets declined marginally to 11.0%, from 11.1% in Q1’2019, due to the faster 15.0% growth in average interest-earning assets, which outpaced the 14.3% growth in interest income,
• Interest expenses rose by 26.7% to Kshs 3.9 bn from Kshs 3.1 bn in Q1’2019, following the 12.0% increase in the interest expense on customer deposits to Kshs 2.8 bn, from Kshs 2.5 bn in Q1’2019, coupled with a 143.4% increase in other interest expenses to Kshs 0.9 bn, from Kshs 0.4 bn in Q1’2019. The growth was mitigated by a 19.1% decline in interest expense from placement liabilities to Kshs 0.1 bn, from Kshs 0.2 bn in Q1’2019. The cost of funds increased to 3.0%, from 2.6% in Q1’2019, owing to the faster 26.7% increase in interest expense, which outpaced the 13.4% increase in average interest-bearing liabilities to Kshs 518.8 bn, from Kshs 457.3 bn in Q1’2019. The Net Interest Margin (NIM) declined to 8.2% from 8.6% in Q1’2019, owing to the faster 15.0% growth in average interest-earning assets which outpaced the 10.6% growth in Net Interest Income (NII),
• Non-Funded Income (NFI) recorded a 15.8% growth to Kshs 8.3 bn, from Kshs 7.2 bn in Q1’2019. The growth was mainly driven by a 34.3% increase in forex trading income to Kshs 1.1 bn, from Kshs 0.8 bn in Q1’2019, coupled with a 12.5% increase in total fees and commissions on loans to Kshs 5.4 bn, from Kshs 4.8 bn. As a result, the revenue mix shifted to 58:42 from 59:41 funded to non-funded income, owing to the faster 15.8% growth in NFI as compared to the 10.6% growth in NII,
• Total operating expenses rose by 46.4% to Kshs 12.9 bn, from Kshs 8.8 bn in Q1’2019, largely driven by a 660.4% increase in Loan Loss Provisions (LLP) to Kshs 3.1 bn, from Kshs 0.4 bn in Q1’2019. The increased provisions is attributed to the bank adopting a cautious stance on the back of the expected impact of the COVID-19 pandemic, coupled with an 23.0% rise in staff costs to Kshs 3.2 bn, from Kshs 2.6 bn in Q1’2019, and a 13.3% growth in other operating expenses to Kshs 6.5 bn, from Kshs 5.7 bn in Q1’2019,
• As a result of the 660.4% rise in Loan Loss Provisions (LLP), the Cost to Income Ratio (CIR) deteriorated by 14.9% points to 64.7%, from 49.8% in Q1’2019. Without LLP, the CIR deteriorated by 1.5% points to 49.0%, from 47.5% in Q1’2019 an indication of a decline in the Banks efficiency levels,
• Profit before tax declined by 20.7% to Kshs 7.0 bn, down from Kshs 8.8 bn in Q1’2019. Profit after tax recorded a 14.1% decline to Kshs 5.3 bn, from Kshs 6.2 bn, with the effective tax rate declining to 24.0% from 29.9% in Q1’2019, and,
• The board of directors announced that it was changing its earlier recommendation of paying a first and final dividend of Kshs 2.5 per share for FY’2019 and instead recommend to the shareholders that no dividends be paid for FY’2019. This decision was made considering the effects of the COVID-19 pandemic and the need to conserve cash to enable the company to respond appropriately to the unfolding crisis in terms of supporting its customers through the crisis and directing cash resources to potential opportunities that may arise as economies in which the group operates begin to recover.

Balance Sheet

• The balance sheet recorded an expansion as total assets increased by 14.4% to Kshs 693.2 bn, from Kshs 605.7 bn in Q1’2019. The growth was supported by a 24.1% increase in the loan book to Kshs 379.2 bn, from Kshs 305.5 bn, coupled with a 14.2% increase in government securities to Kshs 157.6 bn from Kshs 137.9 bn in Q1’2019. The growth was subdued by a 15.3% decrease in placements to Kshs 35.1 bn, from Kshs 41.4 bn in Q1’2019, coupled with a 2.7 % decline in property and equipment to Kshs 11.4 bn, from Kshs 11.7 bn,
• Total liabilities rose by 13.0% to Kshs 576.8 bn from Kshs 510.2 bn in Q1’2019, driven by a 16.5% increase in customer deposits to Kshs 499.3 bn, from Kshs 428.5 bn in Q1’2019. Deposits per branch increased by 9.9% to Kshs 1.7 bn, from Kshs 1.5 bn in Q1’2019, with the number of branches increasing by 17 to 300 branches in Q1’2020, from 283 in Q1’2019. Borrowings, on the other hand, rose by 3.2% to Kshs 52.6 bn, from Kshs 51.0 bn in Q1’2019,
• The faster 24.1% growth in loans as compared to the 16.5% growth in deposits, led to a growth in the loan to deposit ratio to 75.9%, from 71.3% in Q1’2019,
• Gross Non-Performing Loans (NPLs) rose by 51.9% to Kshs 44.6 bn in Q1’2020, from Kshs 29.4 bn in Q1’2019. Consequently, the NPL ratio deteriorated to 11.2% in Q1’2020, from 9.2% in Q1’2019, attributable to a faster 51.9% growth in Non-Performing Loans, which outpaced the 25.5% growth in gross loans. The main sectors that contributed to the deterioration in asset quality were large enterprises and SMEs sectors contributing 13.2% and 12.5%, respectively, to total NPLs. The group’s South Sudan and Tanzania subsidiaries recorded high NPL ratios of 40.8% and 40.5%, respectively. With general Loan Loss Provisions increasing by 57.2% to Kshs 15.1 bn, from Kshs 9.6 bn in Q1’2019, the NPL coverage improved to 45.8% in Q1’2020 from 43.9% in Q1’2019,
• Shareholders’ Funds grew by 22.0% to Kshs 115.3 bn in Q1’2020 from Kshs 94.5 bn in Q1’2019, supported by a 24.9% increase in retained earnings to Kshs 104.4 bn from Kshs 83.6 bn,
• Equity Group remains sufficiently capitalized with a core capital to risk-weighted assets ratio of 17.5%, 7.0% points above the statutory requirement of 10.5%. In addition, the total capital to risk-weighted assets ratio came in at 21.0%, exceeding the statutory requirement of 14.5% by 6.5% points. Adjusting for IFRS 9, the core capital to risk-weighted assets stood at 17.8%, while total capital to risk-weighted assets came in at 21.3%, and,
• The bank currently has a Return on Average Assets (ROaA) of 3.3%, and a Return on Average Equity (ROaE) of 20.7%.

Key Take-Outs:

1. The bank’s geographical diversification strategy has continued to emerge as a net positive, with the bank’s various subsidiaries in Uganda, DRC, Rwanda, Tanzania, and South Sudan cumulatively contributing 25.0% of the bank’s total profitability and 28.0% of the group’s total asset base. However, given the high NPL ratios in the group’s South Sudan and Tanzania subsidiaries of 40.8% and 40.5% respectively, the group will need to improve its credit assessment in these countries to bring down the high NPL ratios. Cumulatively, the group’s subsidiaries recorded an 18.2% increase in their Profit after Tax (PAT) to Kshs 1.3 bn, from Kshs 1.1 bn in Q1’2019, with the Tanzanian branch recording a loss of Kshs 0.07 bn in Q1’2020 from the earlier recorded PAT of Kshs 0.10 bn in Q1’2019. Total assets in the bank’s regional subsidiaries grew by 27.2% to Kshs 206.6 bn in Q1’2020, from Kshs 162.4 bn in Q1’2019. Improved efficiencies in the subsidiaries saw their cost structure contribute to the Group, improve to 36.0%, from 37.0% in Q1’2019,
2. Increased innovation and digitization have seen 97.0% of all transactions of the bank is done on alternative channels, with mobile transactions taking up 79.0% of all loan transactions, and agency banking contributing 11.0% of all transactions. However, in terms of the value of transactions, branches contributed 49.0% of the value of all transactions, while mobile and agency banking contributed 26.0% and 17.0%, respectively. This highlights the transformation of branches to handle high-value transactions. This transformation aids the bank by offering its ecosystem banking products to corporate and SME clients,
3. The Group’s Non-Funded Income recorded a 15.8% growth to Kshs 8.3 bn, from Kshs 7.2 bn in Q1’2019. The growth was mainly driven by a 34.3% increase in forex trading income to Kshs 1.1 bn, from Kshs 0.8 bn in Q1’2019, coupled with a 12.5% increase in total fees and commissions on loans to Kshs 5.4 bn, from Kshs 4.8 bn. However, with the bank’s alternative channels gaining prominence in the frequency of transactions, we expect this to contribute positively towards the NFI revenue stream. With the banks’ NFI contribution to total income currently at 41.9%, it is still way above the current industry average of 22.8%, and,
4. The bank’s asset quality deteriorated, with the NPL ratio deteriorating to 11.2% in Q1’2020 from 9.2% in Q1’2019. The main sectors that contributed to the deterioration in asset quality were large enterprises and SMEs sectors contributing 13.2% and 12.5%, respectively, to total NPLs. Key to note, South Sudan and Tanzania subsidiaries recorded high NPL ratios at 40.8% and 40.5%, respectively. The two countries cumulatively contributed 3.5% of the group's loan book. With the repeal of interest rate cap law, the bank has ramped up its loan disbursement to its customers in the region and will have to be more prudent on its credit assessment in these markets to bring down the high NPL ratios in some of its regional subsidiaries.

Going forward, the factors that would drive the bank’s growth would be:

1. Channeled diversification is likely to further improve on efficiency with emphasis on alternative channels of transactions, as the bank rides on the digital revolution wave, thereby further improving the cost to income ratio by cost rationalization and revenue expansion. This will likely propel the bank’s prospects of achieving sustainable growth, as it replicates its successful business model across its various regional subsidiaries, and,
2. The bank’s operating model of enhancing balance sheet agility is likely to place the bank in a prime position to take advantage of any opportunities that may arise, such as attractive inorganic growth via acquisitions or fast lending with the repeal of the interest rate cap law. The bank’s balance sheet agility is seen with a liquidity ratio of 51.6%, a loan deposit ratio of 75.9%, and a core capital to risk-weighted asset ratio of 17.5%.

Below is a summary of the bank’s performance: