KENYA - KCB BANK UPDATE JUNE 2012

Dear All,



Please find our update on KCB Bank Limited.



We maintain our STRONG BUY recommendation on KCB Bank Limited (KCB) with a fair value of KES 27.50, representing a 19.6% upside from the current price of KES 23.00. Our positive sentiments are supported by sound balance sheet growth over the next 2 years (18.8% CAGR - driven by 10.1% and 13.0% CAGR in lending and customer deposits respectively) and profitability (16.4% CAGR) mainly from expected reductions in cost-to-income (51.8% in FY13). With a higher than sector forward dividend yield (8.5% in FY12), KCB provides an attractive entry point among the large cap Kenyan banks.

· Attractive relative valuation with a forward P/B of 1.3x - KCB trades on a forward P/B and P/E of 1.3x and 5.8x, a 38.1% and 24.7% discount to our large cap sector weighted average of 2.1x and 7.7x, respectively, making it the cheapest large cap bank in the Kenyan Banking sector. KCB also has one of the highest forward dividend yields of 8.5%, against our sector average of 7.1%, providing an attractive entry point in the sector.

· NIMs likely to be squeezed (if not stable) in FY12 - Although we estimate WAIR on loans to be up to 14.0% (+40bp y/y), with focus on increasing wholesale deposits (20.0% of deposits in 1Q12), recent reduction in the base lending rate to 22.0% (from 24.0%) and about 20.0% of deposit book consisting of fixed deposits (at an average 13.0% interest rate), a squeeze (if not stable) in Net Interest Margins (NIM) is likely for FY12 (8.4%; -140bp y/y). Our argument is further supported by lower loan volumes, owing to the high interest rate environment, that we believe will persist until 1Q13 (if not later) and higher cost of funds (+110bp y/y to 2.8%) from increasing competition for customer deposits in the banking sector. We highlight that in 1Q12, KCB’s cost of funds increased 90bp q/q (+210bp y/y) to 2.8%. We are also of the view that the bank will not increase lending rates in order to avoid an increase in non-performing loans.

· Focus on non-funded income remains crucial to drive earnings - KCB’s non-funded income-to-total income (3-yr average of 38.6%) has often lagged industry average (41.0%). For FY12, we believe this ratio will increase to 43.5% (+270bp y/y) supported by growth in fees & commission income (+17.0% y/y), forex income (15.0% y/y) and other income (15.0%). We note that investment securities worth KES 10.2bn (1Q12), mainly bonds, are held as AFS, which the bank purchased during the peak of high interest rates. We believe this provides for upside risk to our non-funded growth if interest rates ease and the bank decides to sell the securities.

· Mortgage business continues to grow - KCB’s mortgage book stood at KES 28.5bn in FY11 (from KES 18.9bn in FY10), an increase of 50.8% y/y, with an even (50/50) split between developers and retail borrowers. With Kenyan GDP growth expected to grow between 3.5-4.5% in 2012, we estimate KCB’s mortgage book in FY12 at KES 32.5bn (+14.0% y/y). Management projects the Kenyan mortgage market to maintain an annual growth of 25.0%-35.0%. However, we believe 2012 is likely to witness a slower growth (10%-15%) due to upcoming elections, high interest rates and possible depreciation of the KES against the major currencies in 2H12. We note that KCB’s mortgage market share is estimated at 37.0%.

· Slow down in asset growth for 2 years - Owing to the high interest rate environment expected, we believe asset growth will be constrained for a period of 2 years. Although we believe KCB will maintain the highest market share in loans (27.0%) and deposits (28.0%), asset growth is forecasted to slow down to 18.8% CAGR over a 2 year period from an average of 30.3% in the past 5 years.

As a result, we estimate an 8.2% y/y and 12.0% y/y loan growth against 12.0% y/y and 14.0% y/y deposit growth for FY12 and FY13 respectively. However, we forecast a higher total asset growth of 23.7% y/y in FY12 as the bank seeks long-term funding.



Please do not hesitate to contact us should you have any queries or comments

... A sweet entry point is what i am seeking for KCB, later in Q3, Q4 2012 and Q1 2013.

I am not of a contrary position. I'm also very bullish on KCB. I notice they expected EPS for fy 2012 to be 3.96, which is very conservative in my opinion. A sweet entry point is what i am seeking for KCB, later in Q3, Q4 2012 and Q1 2013.

Kestrel Capital is projecting a 6% increase in EPS for FY 2012 and a rights issue in 2014.