Valuation Summary

• We are of the view that NIC Group is a “Buy” with a target price of Kshs 37.0, representing an upside of 40.2%, from the current price of Kshs 26.4 as of 27^th March 2020, inclusive of a dividend yield of 6.6%,
• NIC Group is currently trading at P/TBV of 0.6x and a P/E of 5.0x vs an industry average of 1.2x and 6.1x, respectively.

Key Highlights FY’2019

• NIC Group and Commercial Bank of Africa (CBA) finalized their merger and are currently operating as NCBA Group with NIC Group’s Group Managing Director (MD) Mr. John Gachora as the Group Managing Director and Chief Executive Officer.

Income Statement

• Core earnings per share declined by 12.4% to Kshs 11.1 from Kshs 12.7 in FY’2018. The performance was driven by a 7.6% decline in total operating income to Kshs 33.7 bn from Kshs 36.4 bn in FY’2018, despite the 15.7% decline in total operating expenses. The variance in core earnings per share growth against our expectations was largely due to the 34.2% decline in Net Interest Income to Kshs 13.3 bn, from Kshs 20.3 bn in FY’2018, against our expectation of a 9.7% increase in NII to Kshs 22.3 bn, The downside was however mitigated by a 15.7% decline in total operating expenses to Kshs 20.4 bn in FY’2019, from Kshs 24.2 bn in FY’2018,
• Total operating income declined by 7.6% to Kshs 33.7 bn in FY’2019, from Kshs 36.4 bn in FY’2018. This was driven by a 34.2% decline in Net Interest Income (NII) to Kshs 13.3 bn from Kshs 20.3 bn recorded in 2018 which outpaced the 25.9% growth in Non-Funded Income (NFI) to Kshs 20.3 bn in FY’2019 from Kshs 16.1 bn in FY’2018,
• Interest income declined by 34.1% to Kshs 25.5 bn from Kshs 38.7 bn in FY’2018. This was driven by a 35.5% decline in interest income on government securities to Kshs 9.2 bn, from Kshs 14.2 bn in FY’2018, coupled with the 34.3% decline in interest from loans and advances to Kshs 15.7 bn, from Kshs 23.9 bn in FY’2018. The yield on interest earning assets declined to 6.3% in FY’2019 from 9.9% in FY’2018, attributable to the 6.8% y/y increase in average interest earning assets to Kshs 419.9 bn, from Kshs 393.0 bn, despite the 34.1% decline in interest income,
• Interest expense declined by 34.0% to Kshs 12.2 bn from Kshs 18.5 bn in FY’2018, following a 32.6% decline in interest expense on customer deposits to Kshs 10.6 bn, from Kshs 15.7 bn in FY’2018. The cost of funds fell to 3.1%, from 4.9% in FY’2018, owing to the 4.2% growth in average interest bearing liabilities, despite the 34.0% decline in interest expense. The Net Interest Margin declined to 3.3%, from 5.2% in FY’2018, owing to the faster 6.8% growth in average interest earning assets despite the 34.2% decline in Net Interest Income (NII),
• Non-Funded Income rose by 25.9% to Kshs 20.3 bn from Kshs 16.1 bn in FY’2018. The growth in NFI was driven by a 14.4% increase in fees and commissions on loans to Kshs 9.4 bn from Kshs 8.2 bn in FY’2018. Other incomes also grew to Kshs 5.6 bn, from Kshs 1.3 bn, recorded in FY’2018. As a result, the revenue mix shifted to 40:60 funded to non-funded income in FY’2019 from 56:44 in FY’2018, owing to the increase in NFI by 25.9% coupled with the decline in NII by 34.2%,
• Total operating expenses declined by 15.7% to Kshs 20.4 bn, from Kshs 24.2 bn in FY’2018, largely driven by a 26.0% decline in staff costs to Kshs 5.6 bn, from Kshs 7.5 bn in FY’2018, coupled with a 19.1% decline in other operating expenses to Kshs 8.5 bn, from Kshs 10.5 bn in FY’2018, however, the decline was mitigated by a 3.1% growth in loan loss provisions (LLP) to Kshs 6.3 bn, from Kshs 6.1 bn in FY’2018,
• The cost to income ratio improved to 60.5% from 66.3% in FY’2018, owing to the slower 7.6% decline in total operating income to Kshs 33.7 bn, from Kshs 36.4 bn in FY’2018, which was outpaced by the 15.7% decline in total operating expenses to Kshs 20.4 bn, from Kshs 24.1 bn in FY’2018. Without LLP, the cost to income ratio also improved to 41.9% from 49.7% in FY’2018, an indication of improved efficiency,
• Profit before tax declined by 7.8% to Kshs 11.3 bn from Kshs 12.3 bn in FY’2018. Profit after tax before exceptional items grew by 9.9% to Kshs 9.8 bn, from Kshs 8.9 bn in FY’2018, while profit after tax and exceptional items, which relates to merger costs of Kshs 2.0 bn, declined by 12.4% to Kshs 7.8 bn in FY’2019 from Kshs 8.9 bn in FY’2018, with the effective tax rate increasing to 30.7% from 27.1% in FY’2018, and,
• The bank recommends a final dividend of Kshs 1.5 per share, inclusive of a Kshs 0.25 per share interim dividend, translating to a total dividend of Kshs 1.75 per share for the year. This translates to a dividend yield of 6.6% at the current price of 26.4, and a payout ratio of 33.4%.

Balance Sheet

• The balance sheet recorded an expansion as total assets increased by 9.1% to Kshs 494.8 bn, from Kshs 453.6 bn in FY’2018. This growth was largely driven by an 11.8% increase in government securities to Kshs 145.0 bn, from Kshs 129.7 bn in FY’2018, coupled with a 4.1% growth in their loan book to Kshs 249.4 bn, from Kshs 239.6 bn in FY’2018,
• Total liabilities rose by 10.4% to Kshs 427.6 bn, from Kshs 387.2 bn in FY’2018, driven by a 10.9% increase in customer deposits to Kshs 378.2 bn, from Kshs 341.0 bn in FY’2018. The growth in liabilities was mitigated by a 29.0% decline in placement liabilities to Kshs 10.9 bn, from Kshs 15.4 bn in FY’2018. Deposits per branch stood at Kshs 8.8 bn with the bank operating 43 branches,
• The faster 10.9% growth in deposits, which outpaced the 4.1% growth in loans led to a decline in the loan to deposit ratio to 65.9% from 70.3%, recorded in FY’2018,
• Gross non-performing loans increased by 16.5% to Kshs 33.7 bn in FY’2019, from Kshs 28.9 bn in FY’2018. Consequently, the NPL ratio deteriorated to 12.6% in FY’2019 from 11.3% in FY’2018, owing to the faster 16.5% growth in gross non-performing loans which outpaced the 4.7% growth in gross loans (after adding back interest suspense),
• Shareholders’ funds increased by 1.5% to Kshs 67.0 bn in FY’2019, from Kshs 66.0 bn in FY’2018, owing to the 186.7% increase in share premium to Kshs 22.2 bn in FY’2019, from Kshs 7.7 bn in FY’2018. The growth was however weighed down by a 16.6% decline in retained earnings to Kshs 36.0 bn, from Kshs 43.1 bn in FY’2018, coupled with a 2.6% decline in proposed dividends to Kshs 2.2 bn, from Kshs 2.3 bn in FY’2018,
• NCBA Group is currently sufficiently capitalized with a core capital to risk weighted assets ratio of 16.6%, 6.1% points above the 10.5% statutory requirement. In addition, the total capital to risk weighted assets ratio is 17.3%, exceeding the 14.5% statutory requirement by 2.8% points. Adjusting for IFRS 9, the core capital to risk weighted assets stood at 17.5%, while total capital to risk weighted assets came in at 18.2%, and,
• NCBA Group currently has a Return on Average Assets (ROaA) of 1.7% and a Return on Average Equity (ROaE) of 11.8%.

Key Take-Outs:

1. NCBA’s Non-funded income (NFI) growth came in at 25.9%, higher than the industry average of 17.1%, mainly supported by the 14.4% increase in fees and commissions on loans to Kshs 9.4 bn from Kshs 8.2 bn in FY’2018,
2. The bank’s NFI to total operating income came in at 60.0% compared to the industry average of 32.6%, meaning that a significant portion of the bank’s revenue came from non-interest income,
3. The bank’s asset quality deteriorated, with NPL ratio deteriorating to 12.6% in FY’2019 from 11.3% in FY’2018. The deteriorating NPL ratio is attributable to the faster 16.5% growth in gross non-performing loans, which outpaced the 4.7% growth in gross loans (after adding back interest suspense).

Going forward, we expect the bank’s growth to be further driven by:

1. The completed merger has enabled NCBA to capitalize on the strengths of the previous entities. We expect the value or “dividends” from the merger to be experienced in 2020

Below is a summary of the bank’s performance: