Mar 22, 2020

Valuation Summary

• We are of the view that Equity Group is a “BUY” with a target price of Kshs 56.7, representing an upside of 52.0%, from the current price of Kshs 38.95 as of 20th March 2020, inclusive of a dividend yield of 6.4%,
• Equity Group is currently trading at a P/TBV of 1.4x and a P/E of 6.5x vs an industry average of 1.2x and 6.3x, respectively.

Key Highlights FY’2019

• Equity Group Holdings’ board of directors entered into a non-binding agreement with shareholders of Democratic Republic Bank of Congo to acquire a majority stake for, a move, which will see it, increase its market share in Congo, having expanded into the region through its subsidiary, Equity Bank Congo. The proposed transaction together with the binding term sheet signed with Atlas Mara Limited to acquire certain banking assets in 4 countries in exchange for shares in Equity Group. These include:

1. 1. 0% of the share capital of Banque Populaire du Rwanda (BPR);
   2. 0% of the share capital of Africa Banking Corporation Zambia (ABCZam) Ltd.;
   3. 0% of the share capital of Africa Banking Corporation Tanzania (ABCTz); and,
   4. 0% of the share capital of Africa Banking Corporation Mozambique Ltd (ABCMoz)

• Equity Group Holdings opened a commercial representative office in Addis Ababa, Ethiopia, which is expected to commence operations in July, in line with the bank’s strategy to expand into 10 African countries by 2020, with Ethiopian market being the first phase of the regional expansion drive to attain Pan African status;

Income Statement

• Core earnings per share increased by 13.8% to Kshs 6.0, from Kshs 5.3 in FY’2018, slower than our projections of a 17.6% increase to Kshs 6.2. The performance was driven by a 12.6% increase in total operating income. The variance in core earnings per share growth against our expectations was largely due to the 14.1% rise in total operating expenses to Kshs 44.3 bn, from Kshs 38.8 bn in FY’2018, which was higher than our expectation of a 10.1% increase,
• Total operating income rose by 12.6% to Kshs 75.8 bn, from Kshs 67.3 bn in FY’2018. This was driven by an 8.6% increase in Net Interest Income (NII) to Kshs 45.0 bn, from Kshs 41.4 bn in FY’2018, coupled with a 19.0% rise in Non-Funded Income (NFI) to Kshs 30.8 bn, from Kshs 25.9 bn in FY’2018,
• Interest income rose by 12.2% to Kshs 59.7 bn, from Kshs 53.2 bn in FY’2018. This was driven by a 13.8% increase in interest income on loans and advances to Kshs 41.5 bn, from Kshs 36.4 bn in FY’2018. Interest income on government securities, on the other hand, rose by 3.5% to Kshs 16.9 bn, from Kshs 16.3 bn in FY’2018. 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. Consequently, the yield on interest-earning assets grew by 0.3% points to 11.3%, from 11.0% in FY’2018, due to the 11.2% growth in interest income outpacing the 8.6% growth in average interest-earning assets,
• Interest expenses rose by 24.8% to Kshs 14.7 bn from Kshs 11.8 bn in FY’2018, following the 17.5% increase in the interest expense on customer deposits to Kshs 11.1 bn, from Kshs 9.4 bn in FY’2018, coupled with a 60.5% increase in other interest expenses to Kshs 3.0 bn, from Kshs 1.8 bn in FY’2018. The cost of funds increased to 2.9%, from 2.7% in FY’2018, owing to a slower increase in interest-bearing liabilities that rose by 15.3% to Kshs 539.5 bn, from Kshs 467.9 bn in FY’2018 that was outpaced by the 24.8% rise in interest expenses. The Net Interest Margin (NIM) remained unchanged at 8.5%, as the NII and average interest-earning assets grew at a similar rate of 8.6% during the year,
• Non-Funded Income (NFI) recorded a 19.0% growth to Kshs 30.8 bn, from Kshs 25.9 bn in FY’2018. The growth was mainly driven by a 41.6% increase in other income to Kshs 6.1 bn, from Kshs 4.3 bn in FY’2018. The growth was also supported by the 13.5% growth in fees and commissions on loans income to Kshs 5.6 bn, from Kshs 4.9 bn in FY’2018, and a 17.1% growth in other fees and commissions to Kshs 15.6 bn, from Kshs 13.3 bn in FY’2018. Forex trading income, on the other hand, grew by 5.9% to Kshs 3.5 bn, from Kshs 3.3 bn in FY’2018, with management noting that the forex income segment benefited from FinTech innovations. As a result, the revenue mix shifted to 59:41 from 62:38 funded to non-funded income, owing to the faster growth in NFI as compared to growth in NII,
• Total operating expenses rose by 14.1% to Kshs 44.3 bn, from Kshs 38.8 bn in FY’2018, largely driven by a 42.8% increase in Loan Loss Provisions (LLP) to Kshs 5.3 bn, from Kshs 3.7 bn in FY’2018, coupled with an 11.8% rise in staff costs to Kshs 12.8 bn, from Kshs 11.5 bn in FY’2018, and a 10.7% growth in other operating expenses to Kshs 26.2 bn, from Kshs 23.7 bn in FY’2018,
• As a result of the 42.8% rise in Loan Loss Provisions (LLP), Cost to Income Ratio (CIR) deteriorated by 0.8% points to 58.5%, from 57.7% in FY’2018. However, without LLP, the CIR improved by 0.7% points to 51.5%, from 52.2% in FY’2018,
• Profit before tax increased by 10.6% to Kshs 31.5 bn, up from Kshs 28.5 bn in FY’2018. Profit after tax recorded a 13.8% growth to Kshs 22.6 bn, from Kshs 19.8 bn, with the difference in growth attributable to the decrease in the effective tax rate to 28.3% from 30.4% in FY’2018, and the deferred tax benefit of Kshs 1.11 bn compared to the deferred tax liability of Kshs 0.7 bn, and,
• The bank recommends a first and final dividend per share of Kshs 2.5, which is a 25.0% rise from the Kshs 2.0 per share paid in FY’2018, which translates to a dividend yield of 6.4% at the current price of Kshs 38.95, and a payout ratio of 41.8%.

Balance Sheet

• The balance sheet recorded an expansion as total assets increased by 17.5% to Kshs 673.7 bn, from Kshs 573.4 bn in FY’2018. Growth was supported by a 23.3% increase in the loan book to Kshs 366.4 bn, from Kshs 297.2 bn, coupled with a 6.2% increase in government securities to Kshs 138.6 bn from Kshs 130.4 bn in FY’2018,
• Total liabilities rose by 17.4% to Kshs 561.9bn from Kshs 478.4 bn in FY’2018, driven by a 14.2% increase in customer deposits to Kshs 482.8 bn, from Kshs 422.8 bn in FY’2018. Deposits per branch increased by 9.9% to Kshs 1.6 bn, from Kshs 1.5 bn in FY’2018, with the number of branches also increasing by 9 to 294 branches. Borrowings, on the other hand, rose by 28.1% to Kshs 56.6 bn, from Kshs 44.2 bn in FY’2018,
• The faster growth in loans as compared to the growth in deposits, led to a growth in the loan to deposit ratio to 75.9%, from 71.3% in FY’2018,
• Gross Non-Performing Loans (NPLs) rose by 23.4% to Kshs 36.6 bn in FY’2019, from Kshs 29.4 bn in FY’2018. Consequently, the NPL ratio deteriorated to 9.5% in FY’2019, from 9.2% in FY’2018, attributable to a 23.4% growth in Non-Performing Loans, which outpaced the 20.5% growth in gross loans. The main sectors that contributed to the deterioration in asset quality were SMEs and Large Enterprise sectors contributing 11.3% and 9.4%, respectively, to total NPLs. The group’s Tanzania subsidiary contributed 38.1% of the NPLs, with South Sudan and Congo contributing 15.5% and 11.5%, respectively. With general Loan Loss Provisions increasing by 34.8% to Kshs 12.9 bn, from Kshs 9.6 bn in FY’2018, the NPL coverage improved to 47.5% in FY’2019 from 43.9% in FY’2018.
• Shareholders’ Funds grew by 17.7% to Kshs 110.7 bn in FY’2019 from Kshs 94.1 bn in FY’2018, supported by a 15.8% increase in retained earnings to Kshs 89.7 bn from Kshs 77.5 bn,
• Equity Group 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 19.8%, exceeding the statutory requirement of 14.5% by 5.3% points. Adjusting for IFRS 9, the core capital to risk-weighted assets stood at 16.7%, while total capital to risk-weighted assets came in at 20.2%, and,
• The bank currently has a Return on Average Assets (ROaA) of 3.6%, and a Return on Average Equity (ROaE) of 22.0%.

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 18.0% of the bank’s total profitability and 27.0% of the group’s total asset base. Improved efficiencies in the subsidiaries saw their cost structure contribution to the Group, improve to 35.0%, from 37.0% in 2018,
2. Increased innovation and digitization have seen 97.0% of all transactions of the bank being 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 19.0% growth to Kshs 30.8 bn, from Kshs 25.9 bn in FY’2018. The growth was mainly driven by a 16.1% increase in total fees and commissions on loans to Kshs 21.2 bn, from Kshs 18.3 bn in FY’2018, coupled with a 5.9% increase in foreign exchange trading income to Kshs 3.5 bn, from Kshs 3.3 bn in FY’2018. 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 40.6%, it is still above the current industry average of 38.0%, and,
4. The bank’s asset quality deteriorated, with the NPL ratio deteriorating to 9.5% in FY’2019 from 9.2% in FY’2018 but still below the industry average of 12.1%. The main sectors that contributed to the slight deterioration in asset quality are SMEs and Large Enterprise sectors contributing 11.3% and 9.4%, respectively, to total NPL. The group’s Tanzania subsidiary contributed 38.1% of the NPLs, with South Sudan and Congo contributing 15.5% and 11.5%, respectively. 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 improve 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 52.1%, loan deposit ratio of 75.9% and a core capital to risk-weighted asset ratio of 19.8%.

Below is a summary of the bank’s performance: