August 30, 2018/Cordros Report
Update: We resume coverage of GUARANTY with a BUY recommendation, following impressive H1-2018 performance. The result showed gross earnings grew by 5.85% y/y to NGN226.63 billion, following a 31.95% growth in non-interest income (NIR), which made up for the 8.96% drop in interest income. PBT and PAT also grew by 8.44% y/y and 14.22% y/y respectively, supported by continued decline in impairment charges (-71.83% y/y), as well as marginal growth in opex (+2.02% y/y).
Strong asset quality: Among peers, GUARANTY leads with the lowest cost of risk (CoR) of 0.29% as at H1-18, following a faster decline in impairment charges than compared to loans. The decline in impairment charges stems from payoff of some of the bank’s loans (particularly in the upstream oil & gas sector), which led to contraction in the loan book. The creative treatment of IFRS 9’s stringent initial adoption adjustments through equities, as opposed to the income statement also contributed to improvement in CoR. However, we expect uptick in CoR to 0.65% by FY-18, hinged on our estimated increase in customer loans by 8.75% in the second half, following management’s guidance to deploy USD700-USD800 million of its foreign placements (constituting cash inflow from the loan repayments) to creation of more loans (particularly to the upstream oil & gas sector).
GUARANTY’s NPL ratio also improved in H1-18, dropping 191 bps YtD to 5.75%, amidst write-off of some telcom exposures (Arise, RCN, and IRS). Notably, the reclassification of some downstream oil & gas exposures (Linetrale, Danium Energy, and Setana Energy) increased the sector’s composition of total NPL to 23% in H1-18, against 2% in FY-17. It is also worth stating that there was an increase in the provision for 9mobile in the first half, which was deducted from equities (together with IFRS 9 adjustments), bringing total provision for the telco to 68% (vs. 30% in 2017FY).
Improvement in Net Interest Margin (NIM): We estimate NIM of 9.6% in 2018E (46 bps above H1-18 and 60 bps below FY-17), with asset yield of 13.12% (64 bps above H1-2018, but 36 bps below FY-2017) and cost of funds estimate of 3.5% (H1-18:3.27%; FY-17: 3.28%) in 2018E.
Our expectation of improved asset yield in H2-18 stems from expected growth in interest earned on loans – following the conversion of USD700-USD800 million foreign placements to loans, as discussed above. The CBN’s new Differentiated Cash Reserves Requirement (DCRR) programme — aimed at incentivizing DMBs to direct credit to the real sector, and to which management signified interest — is also supportive of our expectation of expansion in GUARANTY’s loan book over the second half. Furthermore, recent upticks in interest rates also make room for improvement in interest earned on fixed income instruments over the second half.
On cost of funds, the slight uptick in our estimate is attributable to the USD276.93 million Eurobond maturing in November, which decreases our interest-bearing liabilities, vis-à-vis interest expense for the period. However, ex-interest expense for the Eurobond, our estimated CoF stands flat at 3.3%. According to management, the bond is unlikely to be renewed upon maturity. Meanwhile, we estimate deposits growth of 13.07% y/y in 2018E, against 10.42% YtD growth in H1-18.
Stable growth in Non-interest income (NIR): Our 9% growth in gross earnings in 2018E is driven by NIR. NIR growth in 2018E is estimated at 27% y/y, with net fee & commission income also estimated to grow by 13% y/y. Despite mixed performance across the bank’s digital platforms — USSD (+65% y/y to NGN1.24 trillion), mobile banking (+35% y/y to NGN2.39 billion), and internet banking (-36% to NGN1.04 billion) – we remain optimistic of positive contribution of e-business income to fees & commission income. Corporate finance fees and commission on forex deals are also expected to boost growth in F&C income in 2018E. We also forecast growth in gains on held-for-trading instruments, as well as on other income to support our forecast of growth of the NIR.
Cost efficiency: GUARANTY has continued to lead peers in cost efficiency over time, with a cost-to-income ratio of 38.39% as at H1-18. In the first half, total opex inched up 2.57% y/y, driven largely by 13% increase in personnel expenses, following review of staff salaries at the start of the year, as well as devaluation impact of translating staff costs of subsidiary companies. We forecast a slower pace of growth in opex in 2018E (+6.0% y/y), compared to FY-2017 (+8%), and a cost-to-income ratio of 36.0% by 2018E, against 36.72% in the previous year.
Estimate and valuation: Overall, we forecast EPS growth of 8.27% y/y and 7.83% y/y to NGN6.27 and NGN 6.70 in 2018E and 2019E respectively. Based on updates to our model, we estimate TP of NGN52.45 for GUARANTY’s shares, translating to upside potential of 34.3%, with BUY rating. On our estimates, GUARANTY trades at forward P/E multiple of 8.36x, below Bloomberg’s Middle East Africa peer median multiple of 9.1x.
