The following analysis is by Rufus Mwanyasi. It was first published in the Business Daily.
Equity Bank just reported an excellent nine months to September net profit of Sh12.8 billion (against Sh11.2 billion in a similar period last year). This translates to earnings per share (EPS) of Sh3.39 on both basic and diluted basis.
The bank’s tangible book value (excluding intangible assets and goodwill) per share rose to Sh17.8, up 13.4 per cent a share. Book value of each share rose to Sh19.2, up 25 per cent year-on-year (YoY).
What’s more, in the month of September, its stock bucked the ongoing bearish run and managed to re-test its July highs at the Sh47 area. Could this be the inflection point investors have been waiting for? I believe so.
Let’s delve into some more positive factors. Non-interest income now accounts for 40 per cent of total operating income, up from 37 per cent.
This shows that the income-diversification programme is working. Recent forays into stockbrokerage and money-transfer businesses have contributed towards this.
Though these segments are highly competitive and suffer from razor-thin margins, positive market position should help contribute to the overall net income growth going forward.
Loans were up 27.5 per cent year-on-year while deposits grew by 30 per cent or by Sh73 billion. This positive trend growth, despite generating a 26 per cent rise in non-performing loans, was validated by the positive net income growth.
Additionally, in the current high rate environment, the bank is well-positioned to benefit. A tight monetary policy will allow the bank to earn even greater profits — on the difference between the cost of funding and lending rates (net interest margin).
Taking into consideration the size of the bank’s balance sheet (Sh445 billion), a small shift in interest rates can have a big impact on the bottom line. The bank recently stated it was charging an average of 24 per cent on loans.
Nonetheless, the bank faces headwinds. To start with, the dismissal of the Kenya Bankers Association (KBA) application seeking to dismiss a class action suit that borrowers had filed against banks, means that litigation risk now becomes a primary factor.
If the suit is successful, this could see banks pay past borrowers’ billions of shillings in compensation for interest rates charged illegally.
Consequently, Equity Bank will now have to set aside a significant litigation reserves until all these legacy issues have been satisfactorily resolved. This will impact negatively on profitability.
Secondly, the bank’s overall expense control at 55 per cent efficiency continues to weigh on its profitability. Compared to key lenders, it ranks poorly: KCB (50 per cent), NIC Bank (46 per cent), CFC Stanbic (52 per cent), StanChart (40 per cent), Diamond Trust (48.6 per cent) and I&M Bank (37.4 per cent).
This is surprising since the bank has been a leader in agency banking, which essentially should be bringing costs lower. During the period under review, operational expenses rose to Sh24 billion or 28.6 per cent.
Thirdly, liquidity ratios dipped to 26.4 per cent, from 30 per cent. Nevertheless, despite the above challenges, this quick analysis shows that the risk/reward equation is still favourable to long-term investors. The bank has shown many areas of improvement on a fundamental basis. Trading at 2.4X book value, cautious investors can layer into the position over time to gain confidence.
