Kenya’s Battered Bank Stocks Look Like Bargains

Kenyan bank stocks were hit hard by the new cap on interest rates, but the resulting selloff left most priced for attractive long-term returns.

Stocks on sale

Every once in a while, the stock market offers you a gift.

Stocks on sale
Photo by Anthony Easton

In Kenya, this appears to be one of those times.

At the beginning of last week, shares of Kenyan banks were already trading at valuations near their lowest in a decade.

Then, on Wednesday, things got crazy.

In a surprise move, President Uhuru Kenyatta signed a law that put a ceiling on banks’ lending rates and a floor under deposit rates.

Interest rates on loans are now capped at four percentage points above the benchmark interest rate, which presently stands at 10.5%. Deposit rates, meanwhile, must now be at least 70% of the benchmark rate.

As you might imagine, the market didn’t like this news one bit.

Bank stocks tanked. They all ended the week at least 6% lower than where they started it. And the prices of three of them, Co-operative (COOP.NR), Equity (EQTY.NR), and NIC (NIC.NR) plunged 23%, 22% and 21%, respectively. The bloodletting continued on Monday with four banks dropping another 9%.

When the closing bell rang on August 29, the price-to-book ratios and dividend yields of the ten largest Kenyan banks looked like this.

Kenyan Bank Valuations as of August 29, 2016

Company  P/B Ratio Dividend Yield
Barclays Bank Kenya (BBK.NR) 1.1 11.5%
CFC Stanbic (CFC.NR) 0.7 9.6%
Co-operative Bank (COOP.NR) 0.8 8.2%
Diamond Trust Bank (DTK.NR) 0.9 1.8%
Equity Group (EQTY.NR) 1.3 7.5%
HF Group (HFCK.NR) 0.4 10.0%
I&M Holdings (IMH.NR) 0.9 4.5%
KCB Group (KCB.NR) 0.8 4.1%
NIC Bank (NIC.NR) 0.6 5.2%
Standard Chartered Kenya (SCBK.NR) 1.3 12.1%

What to Expect Now

Now, I don’t want to spend too much time discussing the merit of the new regulations, but, in their wake, I think the following three things are near certainties:

  • Banks’ growth rates will slow.
  • Large banks will continue to find ways to make money.
  • Banks’ asset quality will improve.

Let’s briefly consider each one in turn.

Bank Growth Will Slow

At present, all Kenyan banks do at least a portion of their lending at interest rates greater than 14.5% (the new, effective maximum rate). And they all pay interest on at least a portion of their deposits at rates lower than the new minimum (7.35%).

Thus, with the new cap and floor in place, the margin between the amount of interest a bank collects and the amount of interest that it pays out will be squeezed, making it tougher for the banks to grow net interest income.

Large Banks Will Remain Profitable Over Long-Term

But don’t shed too many tears for your banker. Most large banks will be just fine.

Sure, banks that do a lot of business with small, riskier customers (e.g. Equity and Co-operative) will likely be hit harder than their peers, but they will find a way to remain profitable in the new environment, whether it be through more efficient loan underwriting, higher fees, or new terms for savings accounts.

It’s important to note that usury laws are not unusual in capitalist economies. In fact, they exist in 49 of the 50 U.S. states (Utah’s the only exception).

Asset Quality Will Improve

Now that the cap on interest rates is in place, the first step most banks will take is to reduce the amount of lending they do to riskier borrowers. After all, why would a bank lend to a small business at a rate of 14.5%, when they can invest in a government bond yielding 15% instead?

As banks shift away from high-interest, unsecured lending, bad loans will no longer present a major threat to the quality of their assets. And, in theory, a bank’s share price should at least be roughly equivalent to its book value per share.

A Conservative Forecast

So, given the above, what kind of returns might we expect from the bank stocks over the next five years?

Let’s make some assumptions for what we’ll see between now and the end of 2021.

  • Banks’ average growth rate will be cut by a third.
  • Bank stocks currently trading at a premium to book value will see this premium cut by a third.
  • Bank stocks currently trading at a discount to book value will see their price-to-book ratios remain at their current level.

Please note that these are strictly assumptions, but I believe them to be relatively conservative. (Let us know in the comments if you think any of them are way off the mark.)

Now that we’ve made these assumptions, we can plug in the numbers and arrive at a forecast return (including dividends) for each Kenyan bank stock. They appear in the chart below.

Company Est. BVPS Growth* Est. P/B Ratio* Est. Annualized Return*
Barclays Bank Kenya 3.9% 1.1 12.5%
CFC Stanbic 2.7% 0.7 9.9%
Co-operative Bank 10.5% 0.8 17.1%
Diamond Trust Bank 16.2% 0.9 17.7%
Equity Group 13.4% 1.2 17.8%
HF Group 6.1% 0.4 14.2%
I&M Holdings 14.4% 0.9 18.1%
KCB Group 15.7% 0.8 19.0%
NIC Bank 13.1% 0.6 17.4%
Standard Chartered Kenya 8.6% 1.2 16.6%

* Forecast to 8.31.2021

A Bevy of Bank Stock Bargains

So, as you can see in the chart above, most Kenyan bank stocks now appear priced to deliver annualized total returns well above 16% over the next five years. KCB, I&M, Equity, DTB, and I&M look like the pick of the litter with 19.0%, 18.1%, 17.8%, and 17.7% forecast returns, respectively.

And if my assumptions turn out to be too conservative, which I believe is more likely than not, the returns to long-term investors at these prices could be very special indeed.

Disclosure: At time of publication, I held a beneficial interest in shares of KCB and I&M Bank.

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10 thoughts on “Kenya’s Battered Bank Stocks Look Like Bargains”

  1. I am so glad I chanced upon this article. In as much as I would have liked to invest in NSE (the bank’s stocks were obvious, yet, smart investors need such information to cherry-pick the best), I didn’t have time to sit and analyse the performance of stocks. I have subscribed to your newsletter…I hope to learn a lot from you.

  2. I agree with you.The current banking shares are a gift.
    For long term investors,they offer a bargain.
    Its also an opportunity for one to average down his buying price(ABP).
    However,speculators are having it tough .
    This is a crucial lesson that it pays to invest in stocks in the long run.
    Im glad i took that route and im seeing its benefits.I have avoided many anxieties and losses.

  3. is there a good online platform one can use from the UK to invest directly in Kenyan stocks, including bank stocks? thank you.

    1. Most of the brokers in Kenya have online trading platforms and you can open an account as a foreigner easily. Personally, I have used SBG Securities (part of Standard Bank Group) and Dyer & Blair (an independent, local broker) and have no complaints about either, but you can find the full list of brokers on the NSE’s website. Good luck!

  4. This bank shares sell off has also led to the whole market correcting which has presented good buying opportunities on other stocks.
    One stock which comes to mind is Kengen,a power generating company which recently did a rights issue and sold the rights at Kshs. 6.55 and gave a dividend payout of 10%.Currently the price has corrected to Kshs.5.95 and the management promised a higher dividend payout policy . This was during the roadshow promoting the rights issue.
    The half year results maintained the growth and was significantly higher than the previous year as earnings from geothermal projects started kicking in thus boosting the bottom line. Assuming the above the dividend will be better than banking stocks as there could be a possibility of capital loss investing in the banking sector Currently.

    Awaitng your valuable response,

    Best regards.

  5. Nice article and very informative. Over the years Kenyan banks have overstated their book value leading to book mismatch…. I still believe they’ll still do it in order to attract more sales of their stocks. That’s why big banks will still find away to stay profitable

  6. My interest is to use shares as a way of saving, with equity bank, which sometime bank hit a height of 63, is there any chances that their share can hit at least ksh 50/share?

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