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Thursday, March 30, 2023

Nigerian Banks: Opportunity or Value Trap?

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Nigerian Bank stocks are cheap, when compared to frontier market peers, despite a majority of them still declaring profits and paying out juicy dividends.

Zenith Bank Plc, Nigeria’s largest Bank by market capitalisation, trades at a price to earnings (PE) ratio of 3.06 and price to book (p/b) value of 0.6x, Guaranty Trust Holding Company the second largest by market capitalisation has a PE of 3.94, p/b value of 0.9x and dividend yield of 12.55 percent.

First Rand, South Africa’s largest bank trades at a PE multiple of 12 and p/b value of 2.62x, for instance.

The two biggest Nigerian Banks just announced annual dividends for 2021 of N3.10 for Zenith and N3.00 for GTCO.

If you want to be a shareholder in GTCO you can buy it on the floor of the stock exchange for N23.65 per share (Friday closing price). In the past year it traded as high as N30/share. Zenith can be bought for N24.20 per share today even as it traded as high as N29 per share in the past year.

Zenith Bank Plc gross earnings rose by 10 per cent to N765.6bn as at December 2021, from N696.5bn recorded in the corresponding period of 2020. Profit before tax also grew by 10 percent to N280.4bn last year, from N255.9bn in 2020.

Guaranty Trust Bank Holdings (GTCO) Plc, net Income dipped by 13.20 percent to N174.84 billion in December 2021 from N201.44 billion the previous year.

Clearly both banks are quite profitable and willing to reward owners of stock, even as they battle headwinds so why are investors pricing the shares at such a discounted level to fair value?

Banks in Nigeria have been facing a number of headwinds which investors fear could dampen profits in coming years.

On the macro-side growth remains sluggish, inflation high, real per capita incomes falling, and unemployment elevated, while on the policy side regulatory uncertainty is beginning to creep in.

The Central Bank of Nigeria (CBN) set the minimum loan-to-deposit ratio (LDR) for banks at 60 percent in a bid to spur lending.

This means that for every N100 in deposits banks hold, they must at least lend out N60 to retail clients and small businesses, instead of binging on ‘risk free’ Federal government securities.

As a result, investors are fretting that profitability of the banks may take a hit in the short to medium term due to potential reduction in relatively easy to earn interest income from lending to the Federal Government, as opposed to the difficult (and inherently risky) business of granting consumer and other forms of retail/SME credit.

Another potential headwind for lenders in Nigeria is the licensing by the CBN of Telecommunication firms (MTN and Airtel) to operate Payment Service Banks (see our front page), which could be a huge game changer for financial inclusion and of course banking as we know it.

The country’s mobile operators; MTN, Airtel, Globacom and 9mobile recently announced their commitment to deepen financial inclusion to at least 90 million customers in about 2 years, once issued payment service banking (PSB) or mobile money licenses.

The four Telco’s combined have some 199.5 million customers, compared to the 21 DMBs with about 30 million bank accounts with unique bank verification numbers (BVNs).

The Telco’s also have the resources to deploy in the coming fight.

MTN Nigeria recently announced its audited 2021 financial statement, reporting an impressive 23.3% growth in service revenue to N1.7trillion or $3.98 billion, despite losing 8million or 10.5% of its mobile subscribers in the year, due to restriction on new SIM sales.

MTN grew profit before tax to N298.7 billion or $720million, translating to 45.5% year-on-year growth and an expanded margin of 18.1%

No Deposit Money Bank in the country currently boasts such revenues.

There is also the issue of attractiveness of bonds relative to equities. With FGN bonds on average yielding around 12 percent per annum.

So are bank stocks currently a value trap?, defined as a stock that appears to be cheap because it has been trading at low valuation metrics such as multiples of earnings, cash flow or book value for an extended time period.

The trap springs however when investors buy into the company at low prices and the stock continues to languish or drop further.

We think the answer is that it is not quite so black and white. Huge opportunities abound in the banking space largely due to huge demographic gains to be had from a population expected to hit 350 million by 2050, cost savings from digital and technology innovations by banks, and the upside from being able to solve the financing needs of millions of Nigerians.

Lenders have no alternative to real banking as opposed to financial engineering, which should largely be left for investment banks and other players in the capital markets.

However there will be winners and losers, and investors will be well served by closely monitoring their holdings of bank stocks, trading around positions, and betting big on those names that are driving innovation in the space.

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