Mar 15, 2020

Valuation Summary

• We are of the view that KCB Group is a “buy” with a target price of Kshs 64.2, representing an upside of 58.7%, from the current price of Kshs 42.7 as of 13^th March 2020, inclusive of a dividend yield of 8.2%,
• KCB Group is currently trading at a P/TBV of 1.1x and a P/E of 5.5x vs an industry average of 1.2x and 6.3x, respectively.

Key Highlight FY’2019

• During the year, KCB Group completed the take-over of National Bank of Kenya Limited by way of a share swap at a ratio of 10:1, 10 ordinary shares of NBK for 1 ordinary share of KCB. This saw KCB Group Plc list an additional 142,979,717shares at the Nairobi Securities Exchange (NSE).

Income Statement

• Core earnings per share increased by 4.9% to Kshs 7.8, from Kshs 7.5 in FY’2018, driven by a 17.4% growth in total operating income to Kshs 84.3 bn, from Kshs 71.8 bn in FY’2018, coupled with a 24.9% rise in total operating expenses to Kshs 47.4 bn, from Kshs 37.9 bn in FY’2018. The growth in core earnings per share was not in line with our expectations of a 6.4% growth, with the variance being attributable to the 24.9% increase in total expenses to Kshs 47.4 bn, from Kshs 37.9 bn in FY’2018, which exceeded our expectations of a 10.8% increase.
• Total operating income rose by 17.4% to Kshs 84.3 bn, from Kshs 71.8 bn in FY’2018. This was driven by a 22.6% rise in Non-Funded Income (NFI) to Kshs 28.2 bn, from Kshs 23.0 bn in FY’2018, coupled with a 15.0% rise in Net Interest Income (NII) to Kshs 56.1 bn, from Kshs 48.8 bn in FY’2018,
• Interest income grew by 12.2% to Kshs 74.4 bn, from Kshs 66.3 bn in FY’2018. This was driven by a 12.0% rise in interest income on loans and advances to Kshs 59.0 bn, from Kshs 52.7 bn in FY’2018, coupled with an 8.3% rise in interest income from government securities to Kshs 14.1 bn from Kshs 13.0 bn in FY’2018. The yield on interest-earning assets, however, declined to 10.9% from 11.1% in FY’2018 attributable to a decline in yields on government securities as well as a decline in lending rates, which saw interest income growing by 12.2%, which was outpaced by the 14.8% growth recorded in the average interest-earning assets,
• Interest expense rose by 4.4% to Kshs 18.2 bn, from Kshs 17.5 bn in FY’2018, following a 5.2% rise in interest expense on customer deposits to Kshs 16.3 bn from Kshs 15.5 bn in FY’2018. Interest expense on deposits and placement from banking institutions however declined marginally by 1.6% to Kshs 1.95 bn from Kshs 1.99 bn in FY’2018. The cost of funds on the other hand declined to 2.8% from 3.2% in FY’2018 owing to a faster 18.4% rise in the average interest-bearing liabilities that outpaced the 4.4% rise in interest expenses. The Net Interest Margin (NIM) remained flat at 8.2%, owing to the 15.0% growth in Net Interest income (NII) matching the 14.8% growth in the average Interest earning assets,
• Non-Funded Income (NFI) rose by 22.6% to Kshs 28.2 bn, from Kshs 23.0 bn in FY’2018. The increase was mainly driven by a 23.4% rise in fees and commissions on loans to Kshs 9.2 bn, from Kshs 7.4 bn in FY’2018. As a result, the revenue mix shifted to 67:33 from 68:32 funded to non-funded income, due to the faster growth in NFI compared to NII,
• Total operating expenses grew by 24.9% to Kshs 47.4 bn, from Kshs 37.9 bn, largely driven by a 201.9% rise in Loan Loss Provisions (LLP) to Kshs 8.9 bn in FY’2019, from Kshs 2.9 bn in FY’2018, coupled with a 14.4% rise in staff costs to Kshs 19.5 bn in FY’2019, from Kshs 17.0 bn in FY’2018,
• Due to the 201.9% rise in Loan Loss Provisions (LLP), Cost to Income Ratio (CIR) deteriorated to 56.2%, from 52.8% in FY’2018. Without LLP however, the cost to income ratio improved, to 45.7%, from 48.7% in FY’2018, and,
• Profit before tax increased by 9.0% to Kshs 36.9 bn, up from Kshs 33.9 bn in FY’2018. Profit after tax grew by 4.9% to Kshs 25.2 bn in FY’2019, from Kshs 24.0 bn in FY’2018 with the effective tax rate rising to 31.8% from 29.1% in FY’2018, which the management attributed to the unwinding of massive deferred tax, which started in FY’2019, created as a result of the implementation of IFRS 9,
• The board of directors recommended a final dividend per share (DPS) of Kshs 2.5, translating to a total DPS of Kshs 3.5 for the year. At the current price of KES 42.7, this translates to a dividend yield of 8.2%.

Balance Sheet

• The balance sheet recorded an expansion as total assets grew by 25.8% to Kshs 898.6 bn, from Kshs 714.3 bn in FY’2018. This growth was largely driven by a 41.0% increase in investment in government and other securities to Kshs 169.2 bn, from Kshs 120.1 bn in FY’2018. The loan book also recorded a 17.4% growth to Kshs 535.4 bn, from Kshs 455.9 bn in FY’2018. The strong balance sheet growth is attributable to KCB acquiring NBK’s assets of Kshs 107.2 bn following the acquisition,
• Total liabilities rose by 28.0% to Kshs 768.8 bn, from Kshs 600.7 bn in FY’2018, driven by a 27.7% increase in customer deposits to Kshs 686.6 bn, from Kshs 537.5 bn in FY’2018, with customer deposits from NBK amounting to Kshs 86.9 bn. Deposits per branch declined by 3.6% to Kshs 2.0 bn from Kshs 2.1 bn in FY’2018, with the number of branches having increased to 342 as at the end of 2019, from 258 in FY’2018,
• The faster growth in deposits as compared to loans led to a decline in the loan to deposit ratio to 78.0%, from 84.8% in FY’2018,
• Gross Non-Performing Loans (NPLs) rose by 93.9% to Kshs 63.4 bn in FY’2019, from Kshs 32.7 bn in FY’2018. The NPL ratio thus deteriorated to 11.1%, from 6.9% in FY’2018, due to the faster growth in Gross Non-Performing Loans (NPLs), which outpaced the growth in loans. Consequently, general Loan Loss Provisions increased by 99.7% to Kshs 28.7 bn, from Kshs 14.4 bn in FY’2018. The NPL coverage increased to 59.5%, from 56.6% 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 14.1% to Kshs 129.7 bn in FY’2019, from Kshs 113.7 bn in FY’2018, as retained earnings grew by 9.6% y/y to Kshs 93.3 bn, from Kshs 85.2 bn in FY’2018,
• KCB Group is currently sufficiently capitalized with a core capital to risk-weighted assets ratio of 17.2%, 6.7% points above the statutory requirement. In addition, the total capital to risk-weighted assets ratio was 19.0%, exceeding the statutory requirement by 4.5% points. Adjusting for IFRS 9, the core capital to risk-weighted assets stood at 18.6%, while total capital to risk-weighted assets came in at 19.5%, 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 asset quality deteriorated, with the NPL ratio increasing to 11.1%, from 6.9% in FY’2018, due to the faster growth in Gross Non-Performing Loans (NPLs), which outpaced the growth in loans. This was after the acquisition of NBK, which saw the non-performing loans portfolio of the Group rise by 93.9% to Kshs 63.4 bn. Management however indicated that, the bank had made recoveries amounting to Kshs 10.0 bn highlighting a payoff of initiatives put in place to clean up the balance sheet of NBK. KCB’s NPL growth was also attributed to a surge to increased uptake of mobile credit products which saw a deterioration in the SME and Micro loan book’s NPL ratio to 14.4% in FY’2019, from 13.0% in FY’2018,
2. There was an improvement in operational efficiency as evidenced by the decline in the Cost to Income Ratio (CIR) without LLP to 45.7% in FY’2018, from 48.7% in FY’2018. This has mainly been driven by increased innovation and digitization has seen with 97.0% of total transactions performed outside the branch comprising of 78.0% on mobile, 15.0% on agency, internet and POS and 4.0% on the ATM, while branch tellers performed only 3.0% of the transactions. This has facilitated the faster growth of transactional income while maintaining a slower pace in the growth of operating expenses. This has also seen a 126.0% growth in non-branch revenue to over Kshs 12.0 bn, and,
3. Non-interest income continued to drive growth coming in at 22.6% y/y to Kshs 28.2bn mainly supported by net fees and commissions, which rose by 39.4% to a combined Kshs 19.8 bn. We further note that the contribution of non-interest income to total income rose marginally by 140bps to 33.4%, which was below the 40.0% target by management.

Below is a summary of the bank’s performance: