Capital Markets

Co-op Bank overhaul seen raising return on equity

COOP

A Co-operative Bank outlet in Nairobi. Co-op returns or ROE have averaged 26 per cent over the past five years. PHOTO | FILE

A transformation of the Co-operative Bank following the appointment of change advisor McKinsey is expected to help increase its return on shareholder funds towards 30 per cent, an investment banker says.

In a report Renaissance Capital said the bank was likely to attain 24 per cent return on equity (ROE) this year as it reduces its costs to be in line with that of its peers.

Renaissance said the restructuring introduced at the rival Kenya Commercial Bank after the appointment of McKinsey some years back had resulted in reduction of the cost-to-income ratio of the country’s largest bank by assets.

Co-op returns or ROE have been decent, said Renaissance, and averaged 26 per cent over the past five years.

“For us to make sense of the McKinsey partnership, we think Co-op’s returns need to gravitate towards the 30 per cent level sustainably over time. We expect 24 per cent RoE in 2015, versus management’s 25 per cent guidance, rising to 27 per cent over the following two years,” said the report.

Taking account of the expected changes, the investment bank upgraded the target price of Co-op Bank to Sh25 a share, 19 per cent higher than the current price.

“Rolling over our forecasts to 2017, we now see 19 per cent potential upside versus current price levels and upgrade our rating to “buy”, from hold’ with a new target price of Sh25.0 (previously Sh20.0),” said the investment bank.

READ: Co-op sends 160 workers home to arrest wage bill

Co-op Bank cost-to-income ratio (CIR)—which measures expenses as a percentage of total income – is the highest among the big banks.

“Co-op’s CIR today sits at 59 per cent, the highest in our universe. Getting this lower in our view will be both a function of cost and revenue improvements over time,” said Renaissance.

The analysts reckon that the transformation at KCB following McKinsey advice saw the bank’s CIR fall from 61 per cent in 2010 to 48 per cent in 2014 – shaving off 13 percentage points in a matter of four years.

The analysts see no reason why the same should not happen at Co-op Bank.

Co-op has been hobbled by loss-making in 23 branches, which is 16 per cent of its 142 branches.

“Costs were also elevated in the second half of 2014, partly driven by ongoing branch expansions.

According to management, 23 (or 16 per cent) of its 142 branches were loss-making as at financial year 2014. Furthermore, operational losses from South Sudan of Sh541 million weighed down on the group’s performance during the year,” said Renaissance.