Zenith Bank Plc recorded a topline growth of 5% in its full-year 2019 result driven by a robust increase in non-interest income. Interest income decreased by 6% on the back of a decline in interest from loans and advances as well as interest income from treasury bills. However, non-interest revenue grew by 30% informed by a 47% surge in trading income. Profit before tax (PBT) rose by 5% while profit after increased by 8% with earnings per share of N6.65k (FY 2018: N6.15k). The company paid a final dividend of N2.50k (FY 2018: N2.50k).
Impressive loan book growth yet interest income declines
Interest income declined by 6% from N440.05bn to N415.56bn in FY 2019 occasioned by a 15% decrease in interest income from loans and advances as well as a 19% decrease in interest income from treasury bills. Interest from loans and advances declined from N273.18bn to N232.95bn due to management risk aversion to risk assets which saw loan book drop YoY by 25% and 1% to N1.79tn and N1.80tn in Q1 2019 and Q2 2019, respectively. However, the trend reversed following the CBN’s minimum Loan-to-Deposit Ratio (LDR) requirement of 60% in August 2019 and adjusted to 65% in October 2019. In a bid to meet the regulatory demand, the group loan book grew YoY by 12% to N2.04bn in Q3 2019 and by 26% to N2.31tn as of year-end 2019. Notwithstanding the impressive loan book growth, interest income from loans and advances decreased by 6%. We think that the decline in interest income was due to lower pricing of credit, and insufficient volume growth to compensate for price decreases. Also contributed to the drop in interest income was a 19% decline in interest from treasury bills from N100.54bn to N81.11bn in FY 2019 as a result of the declining lower yield and decline in investment compared with the prior period.
On the other hand, interest expense grew YoY by 3% from N144.46bn to N148.53bn in FY 2019 driven by a 15% significant growth in customers’ deposits to N4.26bn as well as the double-digit growth in interest expense on savings account and time deposits by 16% and 12%, respectively. Though, interest expense grew, the group’s cost of funds moderated by a 10bps to 3% due to cheaper retail deposits. According to management, the muted decline in the group’s cost of funds despite the low-interest-rate environment was due to interest on savings account anchored at 4%. Thus, net interest income contracted by 10% from N295.59bn to N267.03bn and net interest margin dropped by 67bps to 8% in FY 2019.
Growth in non-interest income amid cost optimization supports PBT
In line with the group’s commitment to improving on its income diversification, non-interest income recorded a substantial growth of 30% from N190.29bn to N246.69bn in FY 2019 driven by a 24% growth in fee and commission income as well as a 47% increase in trading income. Fee and commission income grew from N92.14bn to N114.67bn primarily due to the surge in fees on electronic products. Fees on electronic products grew impressively by 108% from N20.42bn to N42.51bn in FY 2019 as the group continue to leverage on its retail drive to grow fees on electronic products. Also, growth of 33%, 15% and 13% in charges on foreign withdrawal, FX transaction and credit-related transactions, respectively, contributed to the increase in fee and commission income. The 47% spike in trading income to N117.80bn was driven by gains in treasury bills trading income which grew from N94.48bn to N114.32bn.
On the backdrop of the group’s drive towards cost optimization, total operating expense grew mildly by 3% from N225.50bn to N231.83bn and cost-to-income ratio improved by 51bps to 49% in FY 2019. Consequently, profit before tax advanced by 5% from N231.69bn to N243.29bn and profit after tax increased by 8% to N208.84bn due to a lower effective tax rate.
Recommendation
We note with concern the downward trend in the two significant drivers of interest income of the group, particularly, the steep decline in interest from loans and advances in FY 2019. Though loan books grew significantly by 26% in FY 2019 on account of CBN’s LDR policy, the gains are yet to reflect in interest income. Our concern is further exacerbated by the more profound drop in revenue from treasury bills – constituting 20% of the group’s interest income. While we expect accretion to interest income to be driven by growth in loan book, we believe that the downtrend in revenue from treasury bills will persist given the low yield environment.
We are also concerned about management’s ability to drive significant growth in loans given the systemic risk occasioned by the coronavirus pandemic. In addition, we are also concerned about the quality of existing risk assets given the depressed commodity prices in the global market.
The group’s FY 2019 financial performance was underpinned by strong growth in non-interest income amid cost optimizations. The increase in non-interest revenue was driven by fee and commission income as well as the surge in trading income.
Given the current regulatory landscape, we are biased to fade optimism on the group’s ability to sustain those gains or to record significant growth across those lines.
Valuation
We deployed the CAPM model in computing for the cost of capital for the group. Considering the high-risk environment, we, however, computed our equity risk premium as the long-term US equity risk premium plus the yield differential on the US 10-year bond and the Nigeria 10-year Eurobond, in a bid to capture the elevated market risk. We maintained our risk-free rate as the yield on 10-year Nigeria federal government bond. We computed beta for the group by regressing 5-year monthly return on the stock to 5-year monthly performance of the market.
We valued the stock using the dividend discount model (DDM) and the residual income approach. The consistent dividend payment history informed our choice for DDM of the group. We also deployed the residual income approach to assess the group’s ability to deliver real returns to shareholders.
Using the DDM, we arrived at a fair value of N11.78k, which is a 13% discount to the current market price of N13.50k. Using the residual income model, we arrived at a fair value of N14.35k, which is a 6% premium to the current market price of N13.50k.
Considering that our choice of valuation models is sensitive to the estimated cost of capital (32%), we used a blend of both approaches to arrive at a fair estimate of N13.06k on the stock and thus, recommend a HOLD.
