Will Kenyan Bank Stocks Sizzle or Fizzle in 2014?

Bank stocks made Nairobi Stock Exchange investors much richer in 2013.

A stable political environment, regional growth, good profits, and a relatively steady interest rate environment kept the bulls running.

But all of that’s in the rear view mirror. What we really want to know is whether these stocks are worth banking on this year. Will their shares pop or drop? Sizzle or fizzle? Jump or slump? Rise or… Well, you get the idea.

Bank stocks made Nairobi Stock Exchange investors much richer in 2013.

A stable political environment, regional growth, good profits, and a relatively steady interest rate environment kept the bulls running.

All bank shares ended up in positive territory, most outpaced the NSE’s All Share Index, and a couple even doubled in market value. What’s more, they paid out some of the most generous dividends on the exchange.

Here’s a closer look at how each bank stock performed during the year.

[table id=189 /]

But all of that’s in the rear view mirror. What we really want to know is whether these stocks are worth banking on this year. Will their shares pop or drop? Sizzle or fizzle? Jump or slump? Rise or… Well, you get the idea.

To help answer that question, I asked for some help from three local experts — one bold bull, one cautious bull, and one bear.

Here are each of their arguments in turn:

The Bull Case
Bullish
Photo by Bernard DuPont

Alistair Gould, Head of Trading at Old Mutual Securities (Kenya)

I’d say that the majority of bank shares aren’t overvalued as we are anticipating strong performance for the 2013 fiscal year, which, coupled with decent dividend payouts, will continue to keep our banks attractive and push the stocks to higher levels.

Moreover, the performance of the banking sector going forward will be driven by increased economic activity from the mining, oil & gas, and construction sectors. We also foresee more uptake of private sector credit in the new year which still leaves room for banks to grow further in 2014.

However, with competition increasing within the Kenyan banking sector, we believe that the performance of each individual bank will be driven by innovation, product development and well-planned geographical expansion. There are still some good picks that investors should try to get in on early in the year. In particular, we like Coop Bank, National Bank, and Equity Bank.

The Wary Bull Case
Photo by Carol von Canon
Photo by Carol von Canon

Isaac Njuguna, Head of Investment at Zimele Asset Management

Listed banks are currently trading at a trailing p/e ratio of 10 times against the average market trailing p/e ratio of 15 times. This suggests they’re undervalued in spite of their recent gains, especially if they report sustained performance in profits in 2013.

However, despite favorable economic growth projections in 2014, one of the sector’s main challenges is the threat of regulation of interest rate spreads.  Various government task forces are investigating why spreads in Kenya are high in relation to banks elsewhere. Regulation of spreads could limit banks’ earnings growth to single digits, and if it were to become reality, one could say banks are over-priced.

If controls on interest spreads don’t materialize, I’m bullish on KCB, Equity, and Co-op Bank.

The Bear Case
Bearish
Photo by Chris Sgaraglino

Vimal Parmar, CFA, Head of Research at Burbidge Capital

With the banking sector trading at a weighted average price/book ratio of about 2.8, roughly 30% of bank stocks are quite overvalued, especially the leading retail banks. Just two of the listed banking stocks trade less than their intrinsic value — CFC Stanbic and National Bank (assuming its recent restructuring yields results).

Going forward, growth in the sector may not be high enough to justify the higher valuations owing to increasing competition not only within the sector but also from the telecoms sector, which has rolled out innovative mobile banking services like M-Shwari.

However, from a technical perspective, investor demand may keep the stock prices in range (if not increase) because they don’t see better alternatives elsewhere.

My Take

When trying to unearth value in banks, I like stocks with low price/book ratios and high returns on equity (ROE).

As you can see in the chart below, such bank stocks are scarce as hen’s teeth in today’s market.

P/B vs. ROE for Kenyan Bank Stocks
P/B vs. ROE for Kenyan Bank Stocks

While the sweet spot in the upper left hand corner of the chart is empty, there’s a bunch of outliers  in the upper right hand corner. These are very profitable banks, but their price is steep. Look for them to underperform the sector as a whole in 2014. Co-operative Bank, NIC, and Housing Finance look like better values.

In sum, I expect most Kenyan banks to finish 2014 higher than where they started, but I don’t expect the sizzling performances of 2013.

Your Turn

What do you expect from the Nairobi Stock Exchange’s bank stocks this year? Do you fall in with bull, wary bull, or bear case? Or another case entirely? Let’s hear it in the comments!

Related Reading

How to Invest on the Nairobi Stock Exchange
What’s in Store for the Nairobi Stock Exchange in 2014?
Ranking Kenya’s Best Bank Stocks

Kenya: A Bonanza for Bank Investors

Jan Schalkwijk of Africa Capital Group traveled to Nairobi recently to meet with the management teams of several large Kenyan companies. The following is his take on three of the Nairobi Securities Exchange’s most prominent banks.

Jan Schalkwijk of Africa Capital Group traveled to Nairobi recently to meet with the management teams of several large Kenyan companies. The following is his take on three of the Nairobi Securities Exchange’s most prominent banks.

Barclays Bank of Kenya: Steady As She Goes

First on my itinerary was Barclays Kenya, which is one of the more conservative banks in Kenya. Their loan-to-deposit ratio is 80% and they chose not to compete for deposits in 2012 as they felt deposits had become too expensive. As a result, their deposits market share has contracted slightly.

Looking over a longer period, however, they have grown nicely, doubling their balance sheet to 118 billion Kenyan Shillings (USD 1.39 billion) in 6 years. Their non-performing loans are at 7% and trending down and their loan impairment stands at 1% and is stable. With new (tighter) banking regulations in the works, they are well positioned relative to more aggressive competitors.

Barclays’ greater Africa strategy is also being reconfigured to a more centralized structure as opposed to the current decentralized set-up whereby local countries report separately to London. This might allow Barclays to become a little less conservative and position itself more opportunistically in order to capitalize on the prospects for growth that abound across the continent.

Equity Bank: Competing With the Mattress

Next stop was Equity Bank. This bank is one of the market’s favorites and for good reason: it has a great business model. Whereas other banks compete with each other, Equity Bank believes its largest competitor is the mattress. As stuffing your money under the mattress has a lousy real rate of return and questionable safety of principal, Equity Bank enjoys a lower and more stable cost of funds than other banks that cater to a more affluent clientele.

Additionally, they have one of the lowest cost-income ratios at 49%, as they use agents rather than branches. They now have 50% of the banking customers in Kenya. I asked whether their international expansion is putting pressure on the cost-income ratio and the answer was a firm “no.” In fact, some of their new East African markets have even lower cost structures than Kenya.

Not much to not like here; the trick is to find a good entry point, valuation wise. One should not be too cheap, however, as often the entrenched market leaders in high growth economies will continue to do well as the pie expands.

Photo by DEMOSH
Photo by DEMOSH
KCB: Appetite for Expansion

The last bank I met with was Kenya Commercial Bank, generally referred to as KCB. Though not as big as Equity Bank, KCB has a robust 14-18% market share in Kenya, depending on what metric you use. With 18% of shares held by the Kenya national social security fund, 51% by local institutional investors, and 7% by domestic retail investors, the bank has a fairly large local ownership constituency. At present, KCB has a significant liquidity ratio of 35.5%, though they are trying to bring that down modestly.

With its eyes on East Africa, the bank is focused on expanding in 5 other countries, including Uganda, Rwanda, Burundi, South Sudan, and Tanzania. In South Sudan their market share is 42%, in Rwanda it is 8% and their minimum target in any country is 5%. Only Tanzania is a bit disappointing at present, with the bank holding only a 4% market share.

Not unlike Equity Bank, KCB also sees its future tied to mobile banking and has been piloting the agency model in Rwanda, where it has 4,100 agents. Though not as efficient as Equity Bank, KCB’s cost-income ratio has been trending positively, declining from 67% to 60% to 57% in recent years, with a target of 50% in the near term.

Back to Basics Banking

What differentiates all these banks from the major banks in the US and Europe is their conservative loan-to-deposit ratios, which on average fall in the 70-85% range vs. 85-120% for their Western counterparts (with the European banks at the riskiest end of that range). Similarly, Kenyan banks enjoy higher net interest margins (10-13% vs. 3-5% in the US) and lower cost-income ratios (not too mention significantly higher growth prospects). Though investors face macro-economic risks in terms of inflation and exchange rates, on a company level the banks look decidedly healthier in Kenya than the too-big-to-fail banks in the developed world. But to the extent that inflation is kept in check and banks don’t have to compete too hard for deposits, the future for Kenyan banks looks very bright indeed.

More on Kenyan Banks

Is KCB Kenya’s Choicest Bank Stock?
Ranking Kenya’s Best Banks
Three Innovative (and Profitable) Kenyan Banks

Is KCB Bank Group Kenya’s Choicest Stock?

When I asked my friend Kamanda Morara of Ashanti Research for his best Kenyan stock pick for 2013 in mid-December, I had no idea that his choice would bear fruit so quickly.

His tip, KCB Bank Group (KNCB:KN), was trading at a price of KES27.50 at that time. This gave it a dividend yield of 6.7% and a trailing P/E ratio of just 6.5.

Someone must have been eavesdropping on our conversation.

The stock now boasts a price of KES33.50 — a gain of nearly 22% in less than two months.

So, I checked back in with Kamanda last week to congratulate him and to ask whether he felt KCB still had room to run.

When I asked my friend Kamanda Morara of Ashanti Research for his best Kenyan stock pick for 2013 in mid-December, I had no idea that his choice would bear fruit so quickly.

His tip, KCB Bank Group (KNCB:KN), was trading at a price of KES27.50 at that time. This gave it a dividend yield of 6.7% and a trailing P/E ratio of just 6.5.

Someone must have been eavesdropping on our conversation.

The stock now boasts a price of KES33.50 — a gain of nearly 22% in less than two months.

So, I checked back in with Kamanda last week to congratulate him and to ask whether he felt KCB still had room to run.

The answer was yes. KCB remains his top Kenyan pick for large investors in spite of its big recent gains. He explains why below.

I was regrettably slow to clue readers in to your top Kenyan stock for 2013. Do you think KCB still offers investors compelling value?

Kamanda Morara: KCB has rallied considerably, but it is still a great pick because of its liquidity (which is a key consideration for international investors) and visibility, which helps in price discovery. Plus, I am confident that the March presidential election will be carried out peacefully, which should drive the entire market higher.

The Nairobi Securities Exchange is home to lots of relatively large bank stocks. What differentiates KCB from the rest?

KM: KCB is the only Kenyan bank that has operations in all countries of the East African Community: Kenya, Tanzania, Uganda, Rwanda, Burundi, and even South Sudan. Moreover, it has a long and rich history in Kenya which dates to 1896. Because of this, it is deeply entrenched in the Kenyan psyche. Kenya identify personally with it.

Kamandar Morara, Executive Director of Ashanti Research

Do you expect the bank to be a rapid grower over the next five years? And, if so, where will the growth come from?

KM: There are three reasons that I expect it to be a fast grower.

First, KCB is still relatively inefficient compared with its peers. Namely, Equity Bank (EQBNK:KN), Barclays Bank of Kenya (BCBL:KN), and Standard Chartered Bank Kenya (SCBL:KN). KCB’s cost to income ratio has been on a downward trend. A further fall in this ratio — even if revenues remain stagnant — will translate into huge profit growth.

The next big growth driver is its regional reach. Kenya’s economy is projected to grow at a rate of at least 5% per year over the next five years. Remarkably, the rest of East Africa is expected to grow even faster. KCB is well placed to finance cross border trade flows that will only increase as regional integration in East Africa gathers steam.

Finally, KCB has not yet fully exploited its potential for cross-selling various banking products. In 2012, the bank began an aggressive foray into asset finance, which had been a sector long dominated by NIC Bank (NICB:KN). And KCB recently overtook Housing Finance (HFCL:KN) as Kenya’s leading mortgage provider. This momentum of growing market share in additional product segments will only grow as KCB continues to leverage on its wide branch network and strong balance sheet.

Does KCB’s mobile money platform, Mobi Bank, hold promise for generating additional profit for the bank?

KM: Mobi Bank is, in my opinion, a “me too strategy.” Most banks in Kenya have embraced mobile banking, and it would be risky for any player to be left out. Mobile banking will deepen penetration of banking in Kenya and grow the sector as a whole.

The company will soon have a new (rather young) CEO, Joshua Oigara. Should this be a concern to prospective investors?

KM: Oigara is young, but he’s supported by a strong executive team that has been running the bank for many years, and it’s worth noting that he was handpicked by the former CEO who presided over a great growth trajectory for the bank.

He also has a strong background in financial management which will be key to cutting costs and enhancing the efficiency of the bank. In terms of the bank’s strategy, he has assured investors that he shall maintain the current strategic plan that has been working for the bank.

It’s good to remember, too, that Co-operative Bank (COOP:KN) appointed a relatively young CEO in the 1990s (Gideon Muriuki) who helped transition it from a relatively small player recovering from the 1998 bomb blast on the American embassy which damaged its headquarters into a one of the top 5 Kenyan Banks by assets and profitability.  I believe KCB has chosen a young, energetic CEO to grow the bank over the long term.

You mentioned that you believe the Kenyan elections will be peaceful. Why are you optimistic about this?

KM: Kenyans have learnt their lessons from the last elections that were held in 2007, and many see no need to fight for a wealthy political class that share more in common than the rest of the country.

An independent electoral commission has been established, and there is now a much more independent judiciary which enjoys the goodwill of most Kenyans. The elections are bound to be carried out in a fairer manner this time, and the losers will have greater confidence in addressing their grievances through the legal system. The new constitution which has reduced the powers of the president and devolved government to 47 counties has reduced the need for fierce jostling for the presidency.

Lastly, on a lighter note, which bank do you personally bank at and why?

KM: I bank with NIC Bank. They have excellent customer service. It’s a niche bank focusing on the middle and upper middle class in Kenya. It is also a great buy from an investment perspective with its low P/E ratio and rapid growth. The reason I have rated KCB higher as a buy is mainly because of the liquidity and market capitalization aspects that are a key consideration for international high net-worth and institutional investors eyeing the Kenyan stock market.

What Do You Think?

Do you think KCB will be one of Kenya’s best stocks over the next 12 months? Will the elections be carried out peacefully? Let us know your thoughts in the comments!

Kamanda Morara is a Chartered Accountant and the Executive Director of Ashanti Research Ltd, a Nairobi-based buy-side investment research firm. At the time of publication, he held shares of NIC Bank in his personal portfolio.

Further Reading

How to Invest in Kenyan Stocks

Ranking Kenya’s Best Bank Stocks

Kenya’s Most Efficient Banks

Ranking Kenya’s Most Efficient Banks

Last week I posted a list of Africa’s 100 largest frontier stocks. You didn’t have to examine the list very closely to see that banks were disproportionately represented. In fact, of the 100 companies, 35 are banks.

So, as Africa investors, we’d do well to develop some skills in analyzing bank stocks.

Today, we’ll start with a basic measure of bank profitability – the efficiency ratio.

Last week I posted a list of Africa’s 100 largest frontier stocks. You didn’t have to examine the list very closely to see that banks were disproportionately represented. In fact, of the 100 companies, 35 are banks.

So, as Africa investors, we’d do well to develop some skills in analyzing bank stocks.

Today, we’ll start with a basic measure of bank profitability – the efficiency ratio.

The Efficiency Ratio

The efficiency ratio is simply the portion of operating revenue that a bank spends on non-interest expenses like staff salaries, rent, provisions for bad loans, and depreciation.

To calculate it, divide a bank’s total operating expenses for a given time period by its total operating income over the same time period. It’s usually expressed as a percentage.

Photo by GenVessel

A low efficiency ratio (under 50%) suggests a lean, mean banking machine. A high ratio (over 70%) may be a clue that a bank is wasting shareholders’ money.

Ranking the Efficiency of Kenya’s Banks

The table below lists the efficiency ratios of Kenya’s 10 listed banks.

[table id=96 /]

What does this chart tell us?

For starters, it says that for every shilling that NIC Bank collected after accounting for interest charges, it kept 54 cents as pre-tax profit. CFC Stanbic kept less than 28 cents.

That’s a huge difference.

Essentially, at this rate of efficiency, CFC Stanbic needs twice as much operating income to generate the same amount of pre-tax profit produced by NIC.

A Note of Caution

Does this mean that we should immediately sell our shares of CFC Stanbic and rush to buy NIC? Absolutely not.

The efficiency ratio is only one piece of the puzzle. A low efficiency ratio may mean that a bank has run out of expansion opportunities and can only increase profits by reducing operating costs. Meanwhile, a high efficiency ratio may indicate a bank that is laying the groundwork for growth by investing in quality staff, services, or facilities.

In future posts, we’ll look at some other analytical tools that will help us separate great bank stocks from mediocre ones.

What Do You Think?

In the meantime, I’d love to hear Kenyan investors’ reactions to the table above. Would you have guessed that NIC and Standard Chartered operate more efficiently than other Kenyan banks? Did it surprise you that CFC Stanbic posted such a high efficiency ratio? Let us know your thoughts in the comments!

Related Articles

Kenya’s Best Bank Stocks

Banking On Africa’s Unbanked

 

Stock Showdown: Ranking Kenya’s Best Banks

So far, we’ve scoped out bank stocks in Nigeria and Ghana, analyzing their profitability, growth, risk, and value to separate the bargains from the bunk.

Now it’s time to turn to Kenya, East Africa’s largest economy. Ten banks call the Nairobi Securities Exchange home. All of them possess different strengths and weaknesses.

Let’s put them through our ranking exercise to help determine which ones merit a more detailed analysis.

So far, we’ve scoped out bank stocks in Nigeria and Ghana, analyzing their profitability, growth, risk, and value to separate the bargains from the bunk.

Now it’s time to turn to Kenya, East Africa’s largest economy. Ten banks call the Nairobi Securities Exchange home. All of them possess different strengths and weaknesses.

Let’s put them through our ranking exercise to help determine which ones merit a more detailed analysis.

1. Profitability

If you’re in the market for a bank stock, chances are you’d prefer one that actually makes money.

Return on Assets (ROA) measures how effectively management deploys the assets under its control. I’ve calculated ROA as after-tax profits from continuing operations divided by average assets. Then, because bank earnings can be inconsistent, I averaged the ROA from the most recent five fiscal years.

Photo by DEMOSH

To calculate a score, I divided the range between the most profitable bank and the least profitable one into deciles. The banks with ROAs in the highest decile were awarded 10 points. Those in the lowest decile scored just one point.

Here’s how they stacked up:

[table id=39 /]

2. Growth

Profitability is great, but Africa’s best banks are constantly growing their assets. They’re tapping new market segments, expanding into new territory, or acquiring smaller competitors. And because the banking industry is particularly conducive to building economies of scale, a larger asset base generally translates into greater profitability.

To measure which banks are growing the fastest, I simply annualized the growth of each bank’s total assets over the most recent five fiscal years.

Here’s what I found:

[table id=40 /]

3. Asset Quality

A bank’s challenge is to lend as much money as possible for the best return possible. In their zeal to do so, some banks end up lending valuable assets to some rather uncreditworthy customers. When these customers default, the loans must be written down to zero – a bad thing for profitability AND growth.

One of my favorite ways to measure a bank’s asset quality is to determine how much of the loan portfolio isn’t performing as planned. I do this by dividing non-performing loans by total loans. A lower ratio implies a lower degree of risk in the bank’s loan book.

Look here to see which banks are Kenya’s most conservative lenders:

[table id=41 /]

4. Value

Investing, of course, is all about value. The most profitable, fastest growing, well-managed bank in Kenya can end up losing you money if the price you pay for it is too dear.

When evaluating bank stocks, I take a close look at price/book ratios. Book value is simply the difference between a bank’s assets and its liabilities. Stocks with low price/book ratios generally have less downside risk. The lower a price/book ratio gets, the less risk there is of the bank disappointing the market and the greater potential there is for it to outperform expectations.

I prefer the price/book ratio over the price/earnings ratio for bank stocks. Why? Because bank earnings can be erratic. Thus, the P/E ratio for a bank coming off a particularly good or bad year will be skewed. Assets, on the other hand, are much less volatile and relatively easy for an accountant to value.

[table id=42 /]

5. Dividend Yield

Dividend yield is a function of both profitability and value. Generous dividends also suggest a confident management team. Dividend cuts typically wreak havoc on a stock’s share price. Therefore, most banks won’t raise dividends beyond a level they believe they can sustain.

[table id=43 /]

Ranking the Banks

Now let’s put all the scores together and count them down from worst to first.

10. National Bank of Kenya – Oh my. This 44-year-old bank doesn’t appear to be aging well. It’s put together a decent ROA of 1.96% over the past five years, but that is the only highlight. A small dividend, anemic asset growth, and high relative price put it at the bottom of the chart. If anyone knows of any redeeming qualities for NBK, please post them in the comments.

9. Co-operative Bank of Kenya – Co-operative Bank occupies one of the most distinctive buildings in the Nairobi skyline, but it failed to make much of an impression in the showdown. It’s been profitable, but its shares are relatively expensive at 2.3x book value.

8. NIC Bank – NIC Bank sports one of the lowest price/book ratios of this bunch at 1.24. But it’s also miserly with its dividend. The shares yield a sector-worst 1.59%. This may reflect the bank’s intention to add more branches to its network at home and elsewhere in the region. It’s re-investing profits in expansion instead of returning them to shareholders. Potential investors should note the bank’s intention to raise additional capital from the market later this year.

7. Barclays Bank of Kenya – BBK’s eceptional profitability and generous dividend will prove tempting to many investors, but its growth rate is the slowest of the sector. Factor in a relatively large bad loan book, and this “blue chip” fails to break into top tier status.

6. Housing Finance Company – This mortgage lender trades at just 74% of its book value, and it offers a substantial dividend, but its profitability pales next to that of its peers, and its non-performing loan ratio is one of the sector’s highest. Still, speculators may want to consider the company’s recent announcement that it will construct 162 new housing units in eastern Nairobi, funded partially out of its own reserves. This could be a very profitable investment considering the capital city’s shortage of affordable housing.

5. CFC Stanbic – It doesn’t seem to be making great use of its asset base, and it pays only a token dividend, but CFC Stanbic is one of Kenya’s more conservative lenders, and it’s available at an attractive 0.56 price/book ratio. Perhaps worth a closer look given its plans to expand into Southern Sudan. Investors should note however that the bank is preparing for a rights issue.

4. Diamond Trust Bank – An impressively solid loan portfolio coupled with surprisingly rapid growth would put DTB near the top of the rankings if it weren’t for its ho-hum dividend yield. The bank is conserving its capital to fund additional expansion. It also plans to raise more money from the market. DTB has already developed an impressive regional footprint, which includes Tanzania, Uganda, and Burundi.

3. Kenya Commercial Bank – KCB takes more risks in its lending than DTB, as demonstrated by its 6.15% NPL ratio, but it also currently offers one of the juiciest dividends on the Nairobi Securities Exchange. This is in spite of an ambitious regional expansion drive which shows no signs of letting up. It’s apparently on the lookout for an acquisition in Uganda.

2. Standard Chartered Bank of Kenya – SCB hasn’t been one of this group’s fastest growers, but it compensates for this with a conservative loan book and generous dividend. It’s not cheap at 2.3x book value, but you’re paying for quality here. And regional expansion is in the cards. Management is exploring the possibility of a rights issue to help fund new operations in South Sudan and Rwanda.

And the Winner Is ….

1. Equity Bank – Perhaps unsurprisingly, the hands down winner is Equity Bank. Incredibly rapid growth paired with excellent profitability make this an incredibly attractive bank. Foreign investors have already discovered it and now own roughly 43% of outstanding shares. I’ve considered buying some many times over the years, but always thought it looked a tad expensive. It’s proven me wrong again and again. It may soon be easier than ever to own a piece of this dynamic operation. The CEO remarked recently that the bank may soon cross-list in London, New York, or South Africa.

[table id=44 /]

What Do You Think?

Does Equity Bank deserve to be head and shoulders above the rest of the field? Which bank stock do you think is the best bargain? Let me know your thoughts in the comments!

[Disclosure: I have no position in any stock mentioned in this article, and I have no intention of taking any within the next 72 hours.]

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