Citigroup says Kenyan bank stocks overvalued

Kenyan bank stocks remain overvalued, operating at optimal return on equity that offers little upside in stock price, says a new report by Citigroup’s global investment banking arm.

In an analysis of KCB, Equity and Cooperative banks – the three biggest indigenous Kenyan lenders – Citigroup say that while the banks have had a good multi-year run in share price, there is no value in current valuations.

“While the Kenyan banks are good “story stocks” and have enjoyed a multi-year run, we struggle to find value. We initiate with a sell/high risk rating on Equity Bank and neutral/high risk ratings on Co-op and KCB,” Citi advised international investors in the report released last week.

In terms of fundamentals, Citi says Kenyan banks have little room for improvement because they already show good balance sheet utilisation, comparing them to Nigerian banks that have a lower utilisation of their assets and deposits.

“For Kenyan banks, it seems that such an opportunity does not exist given that loans relative to both assets and deposits are already above average, unless these banks can materially increase their deposit bases,” said Citi.

In effect, this leaves the stocks paying the price for the prudent management and better return on both equity and assets – factors which have, in Citi’s view, driven the shares to their optimal value.

Equity, Co-op and KCB have touched all-time closing highs of Sh59, Sh22 and Sh60 respectively within the past two months. According to Citi projections, the fair value price of the three stocks lies at Sh37 for Equity, Sh20 for Co-op and Sh53 for KCB.

Citi, in its bearish outlook on these stocks, says that investors have also failed to account for the possibility of the Central Bank of Kenya (CBK) increasing capital requirements for the sector, which in this case would leave Cooperative with a need to raise additional capital.

Other countries in Africa, such as South Africa and Nigeria, have higher capital requirements, and some market players have suggested that CBK ought to consider raising the requirements for Kenyan banks to enable them participate in larger lending ventures.

“Co-op still reports its capital ratios under the Basel 1 framework, and has not disclosed how much of a drag the transition from Basel 1 to Basel 2 will exert on its capital ratios. It also has a higher cost structure compared to peers,” said the report.

Citi, however, noted that it did not find a relationship between the level of foreign investor participation in the market and the valuation of the stocks.

Other recent research on the Kenyan financial sector, notably by London-based investment bank Exotix and Old Mutual Securities, paints a more bullish picture on bank stocks. Exotix forecast bullish times ahead for financial stocks, with banks expected to reduce costs and increase penetration in the retail, small and medium enterprise sectors.

The Exotix report published last month focused on five banks namely CFC Stanbic, Co-op, Diamond Trust, KCB and NIC, noting that they are likely to reduce cost-to-income (CTI) ratio – widely used to measure the performance of a bank – as they grow their income.

It forecasts the ratio in the coming two years will drop to about 43.5 per cent from the current 50.2 per cent, thereby lifting performance of the stocks.

Old Mutual Securities’ research on KCB focused on the lender’s growing non-interest income, saying it will likely cover for any drop in interest margins, keeping compounded annual growth rate (CAGR) above 10 per cent for the next four years.

“We still believe the stock is under-priced. Our model suggests fair value of Sh60.73 per share vis-à-vis the current price of Sh55.50 per centshare.

“Our investment case is informed by solid asset growth (four-year CAGR of 14.5 per cent to financial year 2017 estimate) thanks to non-funded income growth driven by diversified channels of both product and service delivery,” said Old Mutual Securities shortly after the firm released quarter three results.