Zenith Bank Plc – Strong Trading Gains Mask Huge Provisioning


March 31, 2018/Vetiva Research 

• Top and bottom line beats estimates, up 47% and 37% y/y respectively

• Loan portfolio moderates 8% y/y, despite strong balance sheet growth

• Liquidity ratio and CAR stand firm at 69% and 27% respectively

• Management guide, IFRS 9 to shave ₦42 billion off shareholders’ fund

Earnings beat estimates, thanks to trading gains
ZENITHBANK released its FY’17 result, posting improved y/y performances across both top and bottom line – up 47% and 37% respectively. Although we had anticipated stronger earnings for the period given the already impressive performance as at 9M’17, Q4 earnings still came in much better than our estimate with FY’17 Gross Earnings and PAT coming in 10% and 14% ahead of our respective estimates. Particularly, we highlight marked deviation from our estimates across a few line items. Whilst Interest Income rose 23% y/y to ₦475 billion (Vetiva estimate: ₦469 billion), Non-Interest Income more than doubled y/y to ₦271 billion, beating our estimate of ₦211 billion and spurring a 47% y/y rise in Gross Earnings. 

According to management, Non-Interest Income was largely driven by trading gains, as well record processing volume of transaction – a trend we attribute to improving business environment. We had highlighted that whilst lower interest rate environment pressures Interest Income, the impact of moderating rates is positive for Non-Interest Income as prices of fixed income instruments appreciate – 23% of ZENITHBANK’s assets is invested in fixed income securities. Also, ZENITHBANK reported Derivative Income of ₦68.7 billion for FY’17, a significant jump from the ₦20.1 billion recorded in FY’16. 

Furthermore, whilst Operating Expense came in higher than we had estimated at ₦227 billion (pressured by a 14% q/q rise in Q4’17), Interest Expense was mildly better than our estimate at ₦217 billion. 

Impairment charge however presented the biggest surprise for the period. Notably, the bank reported a loan loss provision of ₦51 billion in Q4’17 standalone – above the cumulative ₦47 billion reported at 9M’17. With the total loan loss expense coming to ₦97 billion for FY’17, the provision line came in significantly ahead of our ₦55 billion forecast – translating a cost of risk of 4.3%. 

Despite this earnings drag, PAT rose from 37%y/y to  ₦177.9 billion, beating our estimate of ₦155.7 billion. With EPS coming in at ₦5.67 (Vetiva estimate: ₦4.96), the Board of Directors proposed a final dividend of ₦2.45 (total: ₦2.70) – translating to a dividend yield of 8.7%. 

IFRS 9 impact looms, loan loss to stay volatile
Given the 170bps rise in NPL ratio to 4.7% in FY’17, we are wary of loan loss expense pressure and anticipate some volatility from this end. Hence, we raise our loan loss provision estimate for FY’18 to ₦86 billion (Previous: ₦42 billion) – translating to a cost of risk of 3.9%. With the implementation of IFRS 9 earmarked for 2018, we highlight that management expects the adoption to lead to a c.₦42 billion reduction in shareholders’ fund. 

Consequently, we anticipate moderation in CAR in FY’18 even as the bank looks to explore opportunities to grow risk assets in strategic sectors. However, we note that ZENITHBANK’s CAR at 27% remains significantly better than the regulatory benchmark of 15%. 

Mixed outlook for FY’18, TP revised higher to 38.11
Save for large deviations around non-interest income and loan loss provision, we highlight that earnings came in largely in line with our estimates. Whilst we maintain our 10% loan growth forecast for FY’18 (down 8% in FY’17), we expect the y/y moderation in interest rate environment to cap Interest Income growth. However, we expect trading income as well as improving transaction turnover to continue to support other non-interest income. 

Given anticipation of possible easing in 2018 and in line with recent rate moderations, we forecast moderation in cost of funds to ease interest expense pressure. Particularly, we expect the strong growth in customer deposit recorded in FY’17 (up 15% y/y) as well as the healthy liquidity and capital adequacy ratios to provide leeway for growth in risk assets in FY’18. 

Overall, we forecast a flat PAT of ₦180 billion for FY’18 – translating to an EPS of ₦5.73. With earnings coming in better than we had estimated, we raise our Target Price to ₦38.11 (Previous: ₦37.09). ZENITHBANK trades at forward P/E and P/B ratios of 5.4x and 1.1x vs. Tier I averages of 5.8x and 1.1x respectively.

Proshare Nigeria Pvt. Ltd.

Proshare Nigeria Pvt. Ltd.

Proshare Nigeria Pvt. Ltd.