November 6, 2017/Cordros Research
In its recently released Q3-17 results, GUARANTY’s gross earnings declined by 19.85%y/y and 12.03% q/q (missed our estimate by 24.27%), with PBT (-1.06% y/y and -3.51% q/q) and PAT (-1.34% y/y and -72 bps q/q) consequently coming in lower (missed our estimates by 11.20% and 3.88% respectively). The key driver of the decline in earnings was a significant contraction in NIR (down 72.80% y/y and 52.75% q/q), which more than subdued the 14.21% y/y (and 74 bps q/q) growth in interest income.
We have cut our gross earnings growth forecast to 3.40% (previously 10.70%) for 2017F to N428.70 billion, on expected deeper contraction in NIR. That said, following a downward revision of costs of risk and opex, amid upward adjustment to cost of funds, we now forecast PBT and PAT growth of 24.31% and 30.39% (previously 26.87% and 28.33% respectively) to NGN205.28 and NGN172.49 billion respectively. As a result, our 2017F EPS of N5.86 is now 1.75% higher than the previous estimate.
Reflecting the lower than expected FX revaluation gains which drove a steep contraction in NIR, we have raised our expected contraction in NIR by 38.72% (previously -24.88%) and estimate NIR contribution to gross earnings to drop to 21.25% (previously 24.33%) in 2017F, compared to FY-2016’s 35.86%. We maintained our 2017F asset yields estimate of 13.60%, however, following a 2.84% cut back in our forecast average interest earning assets, we now expect interest income to grow by of 27.62% y/y (previously 31.34%) to NGN334.99 billion – reflecting the persisting high yields on interest earning assets.
We raised our cost of fund estimate by 15 bps to 3.30% for 2017F (34 bps y/y uptick from 2.81% in FY-16), resulting in 19.13% y/y (previously 19.77%) growth in interest expense to N79.93 billion, reflecting the relatively tight domestic system liquidity – which has driven upward repricing of deposits – as well as the impact of the US Feds rate hike. However, we expect the impact of the higher funding cost will be marginal on net interest margin, wherein we forecast a 134 bps y/y expansion to 10.35% (previously 10.43%).
We expect a cut back in loan loss provisioning in 2017F on possible restructuring of some NPLs (we maintained NPL of 3.55%) owing to the (1) successful restructuring of exposures across sectors, specifically FCY loan exposures, (2) relative stability in oil production and prices, with attendant impact on oil & gas upstream obligors cash flow, and (3) improved FX availability to manufacturers and oil & gas downstream obligors. Given the ongoing restructuring of Etisalat Nigeria (now 9Mobile) for a possible sale in the interim, we believe a haircut is eminent on the exposure. And while the bank’s management guided to a less aggressive impairment provisioning this year, given the c.N60 billion collective impairment booked in the previous year, we have adopted a more conservative approach for provisioning during the year. Hence, we lowered forecast cost of risk to 1.15% (previously 2.15%), translating to a 73.19% y/y decline in impairment charge to NGN17.50 billion in 2017F.
While opex rose 13.06% in 9M-17, following persisting FX translation impact on operating cost, staff cost, and operating lease, it contracted 37.28% q/q and 27.09% in Q3. Accordingly, we have cut our opex growth forecast to 8.57% y/y (previously 15.11%), translating to a cost to income ratio of 35.64% (previously 34.78%) and operational leverage of 3.9x, compared to 33.03% and 4.0x, in FY-16, respectively.
While noting the (1) limited room for any significant growth in FX trading and revaluation gains with the relative stability of the naira and (2) impact of the adoption of IFRS 9 from 2018F, which should drive 49 bps expansion in cost of risk, we believe GUARANTY’s long position in fixed income securities will drive growth in interest income over 2018-2019F, with estimated average growth of 7.89%. We raised our target price marginally by 86 bps to N42.81 (previous: N42.45) and rolled forward our valuation to 2018.
Our current 12-month TP implies upside potential of 2.62% from current levels; consequently, we recommend a HOLD on the stock. GUARANTY is currently trading at 2017F P/BVPS of 2.1x (above peer average of 1.0x and a 5-year average of 1.9x) and 2017 FP/E of 7.2x (above peer average of 4.9x and a 5-year average of 6.8x).
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