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Balancing act
In our view, the near-term focus on Co-operative Bank of Kenya isn’t so much the expected earnings recovery in H2:12E, but the bank’s near-term strategy and its ability to balance a delicate act of asset growth, expansion and capital going forward.
48% FY12E net earnings upgrade on NII and CoR: The increase in the bank’s interest income has been one of the main themes in H1:12 and, in our view, it was evident from Q3:11. However, Co-operative Bank’s benefit from the lending rate increase lagged that of its peers. As a result of improved visibility, our numbers show a +48% increase in PAT.
Ksh1.84/share NPV of cost savings expected: We believe that the cKsh3.1bn one-off cost from current expansion, core banking and new branches is likely to come to an end; that is c24% of the bank’s current cost base. This translates into a Ksh0.39/share FY13E EPS gain or Ksh1.84/share valuation if we add an 11% discount rate and apply a multiple of 6x. This is c17% potential upside to our reference share price.
RWA growth capped at c17% on internal capital generation: If our earnings forecast up to FY14E proves correct, Co-operative Bank’s retained earnings or that which we use as proxy for free cash flows would cap RWA growth at a c17% on average for the next 3 years. This compares to the c36% average annual RWA growth of FY:08-FY:11. Our scenario also exposes a slow core capital ratio build-up of less than 60bps on average per year, despite material excess capital on a 12.5% floor. Using a more conservative 16% core CAR suggests that Co-operative Bank is potentially running out of capital, based on our analysis.
Ksh6-10bn fresh capital likely to strike the growth/solvency balance: We estimate that Co-operative Bank may require Ksh6.3-10.2bn for both risk growth and balance sheet strengthening in the absence of a strong parent company, with a dilution range on this basis of 23-38% on our estimates. This should enable the bank to grow RWA between 15%-30% p.a. and achieve a CAR of 18.5%-23%. The bigger question may be around the Co-operatives’ willingness to take up their rights or accept a level of dilution. We discuss the possible outcomes in this report.
Dilution trumps upside, new TP Ksh11, reiterate SELL: Unfortunately for Co-operative Bank, our new target price is doubly hit by including the bonus issue to our number of shares and by building in the anticipated c30% dilution from what we view as a hardly avoidable capital raise. We cut our target price to Ksh11 from Ksh13 previously. On this basis, the stock trades at a FY13E P/E of 7.9x and P/B of 1.85x, we see better value and upside in KCB (BUY, TP Ksh30).