Culled—Proshare
April 21, 2020
By CardinalStone Research
Executive Summary
The COVID-19 pandemic and oil price shocks have led to costly global economic disruptions. With Nigeria hugely reliant on a well-functioning global economy for trade, and stable oil prices for FX earnings and budget funding, there is a strong probability that the domestic economy will plunge into another recession in 2020. Nigerian banks are hardly insulated from the impact of the shocks, given how intertwined the financial industry is with the workings of macroeconomy. In some ways, parallels are already being drawn with the most recent banking system crises, and the resilience of the sector is being called into question once again.
In our FY’20 outlook report, we highlighted that regulatory concerns, credit creation, movement in the yield environment, and NIR worries were the key issues banks were likely to grapple with in the year. Clearly, the rapid spread of COVID-19, alongside its disruptions to pre-existing economic and socio-cultural dynamics, has expanded the pressure points likely to further strain banks’ performances in FY’20.
Market reaction towards risk assets have been largely overwhelming, with investors rotating towards safer havens. Nigerian equities have been beaten, with the NSE banking index losing 25.9% in the last three months. In this report, we compare valuations with those of peers across Middle East and North Africa (oil producers in particular), Sub-Saharan Africa, and Frontier Markets. Our analysis suggests not only a persistent undervaluation, but also a widening valuation discount between Nigerian banks and peers.
We note that the risks remain. Persistent weakness in oil prices could have inimical consequences for banks’ exposure to oil and gas. It is unclear how long the COVID-19 pandemic will linger, but a committee of African Finance Ministers has suggested that it could take Africa between two and three years to fully recover from the current economic impact of the viral spread. What is clear, however, is that it is highly probable that Nigeria, like the rest of the world, could be set for another recession in 2020.
Nigerian bank valuations have toppled
COVID-19 disruptions and oil price shocks have sent Nigerian bank valuations reeling, with our coverage trading around its 5-year low price-to-book (P/Bv) of 0.40x on average.
We see two key drivers for the recent deterioration in valuation of banks:
- Foreign investors (FPIs) have largely rotated out of risk assets, wary of the impact of COVID-19 and oil shocks. Notably, FPIs were mostly on the sell side before the first COVID-19 case was reported in Nigeria, with net foreign outflows from equities amounting to $154.0 million by February 2020 (vs. $102.1 million for the whole of 9M-19). Since that index COVID-19 case, investors appeared to have extended their rotation into short-dated government instruments to hedge against potential weaknesses in equities and position for possible yield reversals in coming quarters. FMDQ data suggests an 88bps contraction in average spot yields on government instruments with one-month to one-year maturities (vs. -94bps between January and February).
2. Parallels are being drawn between the current COVID-19-cum-oil crises and the oil price shock of 2015/2016, which caused an economic recession and left Nigerian banks stressed. This has possibly heightened aversion towards holding Nigerian risk instruments. While we realise need for caution on account of historical precedent, we note the following:
Peer comparisons are suggestive of implied undervaluation
Nigerian banks have historically traded at a price-to-book (P/Bv) discount to peers across Sub-Saharan Africa (SSA), oil-producing Middle East & North Africa (MENA), and Frontier Markets (FM). However, over the last 24 months, we note that the valuation discount has widened on average to 52.9% in April 2020 from 29.4% in April 2018.
Regression valuation analysis of Nigerian banks versus peers
Using regression analysis, we compare the valuation of Nigerian banks (our coverage) against peers in SubSaharan Africa (SSA), oil-producing Middle East & North Africa (MENA), and Frontier Markets (FM). Our regression sample utilises daily P/Bv data and available Return on Equities (ROE) numbers over the last 24 months. Our analysis suggests that the predictive power of the P/Bv and ROE regression is stronger for the Nigerian banking sector (R2 of 83.5%) and the Frontier Market universe (R2of 52.0%) compared to MENA (R2 of 1.0%) and SSA (R2 of 33.0%).
We, therefore, attempt a forecast of FY’20E P/Bv of the Nigerian banking sector using the regression equation from our Frontier Market analysis. Our assessment suggests an implied average P/Bv of 0.61x for our coverage banks vs 0.43x currently. In arriving at this result, we applied a valuation discount of 30.0%, which represents a reversion to the valuation discount of 29.4% at the beginning of our assessment period. Our lower discount, compared to historical average of 39.3%, takes into account the recent fall in Nigerian risk-free rates (10-year bond yield – December 2018: 15.5%, June 2019: 14.2%, December 2019: 11.3%, April 2020: 12.0%) which could most likely to lead to moderation in the cost of equity of Nigerian banks
Post-COVID-19 catalysts could induce the necessary repricing
While we acknowledge that there could dire implications from the COVID-19 induced disruption and oil price shocks on banks’ performance in FY’20 and, possibly, FY’21, we note critical catalysts that, in our view, could be instrumental to the repricing of banks’ valuations when normalcy returns:
