Mar 22, 2020

Valuation Summary

• We are of the view that Co-operative Bank is a “BUY” with a target price of Kshs 18.1, representing an upside of 49.8%, from the current price of Kshs 12.75 as of 20th March 2020, inclusive of a dividend yield of 7.8%,
• Co-operative Bank is currently trading at a P/TBV of 1.0x and a P/E of 5.2x vs an industry average of 1.2x and 6.3x, respectively,

Key Highlights FY’2019 

• The Bank was the overall winner in the Client case study- Financing SME category; in Kenya Bankers Association Catalyst Awards 2019 and in the 2019 East African Financial Reporting (FiRe) Awards, the bank was named Overall Winner in the Environmental Sustainability Reporting category,

Income Statement

• Core earnings per share increased by 12.4% to Kshs 2.4 in FY’2019, from Kshs 2.2 in FY’2018, which was not in line with our projections of a 4.1% increase. The performance was driven by a 10.9% increase in total operating income to Kshs 48.5 bn in FY’2019, from Kshs 43.7 in FY’2018, which outpaced the 8.2% increase in total operating expenses. The variance in core earnings per share growth against our expectations was largely due to the 8.2% rise in total operating expenses to Kshs 27.8 bn in FY’2019, from Kshs 25.7 bn in FY’2018, which was not in line with our expectation of an 11.3% increase to Kshs 28.6 bn,
• Total operating income increased by 10.9% to Kshs 48.5 bn in FY’2019, from Kshs 43.7 in FY’2018. This was due to a 33.1% increase in Non-Funded Income (NFI) to Kshs 17.2 bn from Kshs 12.9 bn in FY’2018. The growth was also supported by the 1.7% marginal growth in Net Interest Income (NII) to Kshs 31.3 bn from Kshs 30.8 bn in FY’2018,
• Interest income rose by 1.4% to Kshs 43.6 bn in FY’2019, from Kshs 43.0 bn in FY’2018. The marginal growth recorded was as a result of a 3.5% decline in interest income from loans and advances to Kshs 31.8 bn, from Kshs 32.9 bn in FY’2018, which weighed down the 16.0% rise in interest income from government securities to Kshs 11.4 bn from Kshs 9.8 bn in FY’2018. Consequently, the yield on interest-earning assets declined to 11.8%, from 12.7% in FY’2018 due to the faster 14.7% growth in interest-earning assets compared to the 1.4% growth in interest income,
• Interest expenses rose marginally by 0.8% to Kshs 12.3 bn in FY’2019, from Kshs 12.2 bn in FY’2018, largely due to a 28.7% rise in other interest expenses to Kshs 1.6 bn from Kshs 1.2 bn in FY’2018. This was offset by interest expense on customer deposits, which declined by 2.1% to Kshs 10.7 bn from Kshs 10.9 bn in FY’2018. The cost of funds declined to 3.6%, from 3.8% in FY’2018, owing to an 8.7% rise in interest-bearing liabilities to Kshs 359.4 bn, from Kshs 330.5 bn in FY’2018 which outpaced the 0.8% rise in interest expenses,
• Non-Funded Income rose by 33.1% to Kshs 17.2 bn in FY’2019, from Kshs 12.9 bn in FY’2018. The increase was mainly driven by the 460.7% increase in fees and commissions on loans to Kshs 3.2 bn, from Kshs 0.6 bn in FY’2018, as well as a 7.2% increase in other fees and commissions to Kshs 9.6 bn from Kshs 8.9 bn in FY’2018. The improvement in NFI was however weighed down by the 6.0% decline in forex trading income to Kshs 2.1 bn, from Kshs 2.3 bn in FY’2018. As a consequence, the revenue mix shifted to 65:35, from 70:30 in FY’2018 owing to the fast growth in NFI,
• Total operating expenses rose by 8.2% to Kshs 27.8 bn in FY’2019, from Kshs 25.7 bn in FY’2018, largely driven by the 37.9% rise in Loan Loss Provisions (LLP) to Kshs 2.5 bn from Kshs 1.8 bn in FY’2018, coupled with staff costs increase of 8.1% to Kshs 12.4 bn in FY’2019 from Kshs 11.5 bn in FY’2018,
• The Cost to Income Ratio (CIR) improved to 57.4%, from 58.8% in FY’2018, following the faster rise in total operating profit that outpaced total operating expenses. Without LLP, the cost to income ratio also improved to 52.1% from 54.6% in FY’2018,
• The bank registered a growth of 12.4% in profit after tax to Kshs 14.3 bn in FY’2019 from Kshs 12.7 bn in FY’2018 and a 14.0% growth in profit before tax to Kshs 20.7 bn from Kshs 18.2 bn in FY’2018, with the effective tax rate declining to 31.6% in FY’2019 from 32.7% seen in FY’2018, and,
• The bank recommends a final dividend per share of Kshs 1.0, unchanged from the Kshs 1.0 per share paid in FY’2018, which translates to a dividend yield of 7.8% at the current price of Kshs 12.75, and a payout ratio of 41.0%.

Balance Sheet

• The balance sheet recorded an expansion as total assets grew by 10.5% to Kshs 457.0 bn in FY’2019 from Kshs 413.4 bn in FY’2018, owing to the increases in government securities by 46.8% to Kshs 117.8 bn in FY’2019 from Kshs 80.3 bn, and net loans and advances by 8.7% to Kshs 266.7 bn in FY’2019 from Kshs 245.4 bn in FY’2018, despite a decrease in placements by 36.1% to Kshs 9.7 from Kshs 15.2bn,
• Total liabilities grew by 9.9% to Kshs 376.2 bn in FY’2019 from Kshs 342.2 bn in FY’2018, which was largely attributable to the 8.7% rise in customer deposits to Kshs 332.8 bn in FY’2019, from Kshs 306.1 bn in FY’2018. Borrowings also recorded a 10.3% rise by to Kshs 26.4 bn from Kshs 23.7 bn in FY’2018,
• The slightly faster 8.72% growth in deposits which outpaced the 8.68% growth in net loans and advances, led to a marginal decline in the loan to deposit ratio to 80.1%, from 80.2% in FY’2018. Deposits per branch increased by 6.0% to Kshs 2.1 bn from Kshs 2.0 bn in FY’2018, as the number of branches increased by 4 to 159 branches,
• Gross Non-Performing Loans (NPLs) increased by 7.5% to Kshs 31.6 bn in FY’2019, from Kshs 29.4 bn in FY’2018. The NPL ratio, however, improved to 11.2% in FY’2019, from 11.3% in FY’2018 owing to faster growth in gross loans by 9.1% outpacing the 7.5% growth in gross non-performing loans,
• General Loan Loss Provisions increased by 13.2% to Kshs 11.3 bn, from Kshs 9.9 bn in FY’2018. The NPL coverage ratio thus improved to 51.8% in FY’2019 from 48.1% in FY’2018, due to the faster growth in General Loan Loss Provisions which outpaced the growth in Gross Non-Performing Loans (NPLs),
• Shareholders’ funds increased by 13.6% to Kshs 79.3 bn in FY’2019 from Kshs 69.9 bn in FY’2018, mainly driven by a 15.6% increase in the retained earnings to Kshs 62.4 bn, from Kshs 54.0 bn in FY’2018,
• Co-operative Bank remains sufficiently capitalized with a core capital to risk-weighted assets ratio of 16.3%, 5.8% points above the statutory requirement of 10.5%. In addition, the total capital to risk-weighted assets ratio came in at 16.8%, exceeding the statutory requirement of 14.5% by 2.3% points. Adjusting for IFRS 9, the core capital to risk-weighted assets stood at 16.3%, while total capital to risk-weighted assets came in at 16.8%, and,
• The bank currently has a Return on Average Assets (ROaA) of 3.3%, and a Return on Average Equity (ROaE) of 19.2%.

Key Take-Outs:

1. Non-Funded Income rose by 33.1% to Kshs 17.2 bn in FY’2019, from Kshs 12.9 bn in FY’2018, exceeding the industry average growth of 18.5%. The increase was mainly driven by the 460.7% increase in fees and commissions on loans to Kshs 3.2 bn, from Kshs 0.6 bn in FY’2018, as well as a 7.2% increase in other fees and commissions to Kshs 9.6 bn from Kshs 8.9 bn in FY’2018. However, the improvement in NFI was weighed down by the 6.0% decline in forex trading income to Kshs 2.1 bn, from Kshs 2.3 bn in FY’2018. As a consequence, the revenue mix shifted to 65:35, from 70:30 in FY’2018 owing to the fast growth in NFI, which was attributable to the increased focus on E-Credit and its mobile banking platform M-Coop Cash to grow commissions, and,
2. The bank’s asset quality improved, with the NPL ratio reducing marginally to 11.2% in FY’2019, from 11.3% in FY’2018 owing to faster growth in gross loans by 9.1% outpacing the 7.5% growth in gross non-performing loans, which is attributable to the implementation of credit management strategies implemented since the beginning of the year such as adherence to credit risk appetite and limits, credit risk early warning indicators, proper credit appraisal and approval mechanisms. The main sectors that contributed to Non-Performing Loans are Trade, Personal Consumer and Manufacturing sectors contributing 32.0%, 18.0% and 16.0%, respectively, to total NPL.

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

1. Business Model Restructuring - The banks’ has continued implementation of “Soaring Eagle” transformation initiatives is expected to drive growth and increase efficiency. The initiatives are set on the following eight key pillars; branch transformation, MSME transformation, sales force effectiveness, shared services and digitization, NPL management and credit processes, cost management, data analytics, and staff productivity. We expect the initiatives to culminate into improved revenue levels, and,
2. Interest rate cap repeal - With the repeal of the interest rate cap, we expect the bank’s Net Interest Margin (NIM) to recover. However, proper credit management strategies should be maintained to prevent the deterioration of the loan book’s quality.

Below is a summary of the bank’s performance: