Non-core Earnings Continue to Support Top Line Zenith Bank Plc (ZENITHBANK)’s interest income rebounded strongly (+11.40% YoY) in Q2:2020, after suffering a 6.65% YoY decline in Q1:2020.
This culminated in a 1.10% YoY growth in interest income to NG216.95bn in the first half of the year, backed by Zenith Bank’s considerable asset growth over the period. However, we note that the current low yield environment continues to weigh heavily on Zenith Bank’s performance as the growth in interest income failed to adequately reflect the growth in assets.
Moreover, the pressure on fee-based income was compounded by the COVID19 pandemic during the period as net fee and commission income declined by 39.97% YoY to NGN33.50bn.
We are concerned that gains from trading assets and FX revaluations remained the key drivers of topline performance in spite of Zenith Bank’s robust earning assets base. We are of the opinion that this may not sustainable as these income lines are highly sensitive to regulatory risks.
This development is not encouraging in view of the heightened instability in the regulatory environment. On a positive note, Zenith Bank’s increased spending on information technology may translate to increased transaction volumes across digital platforms given its robust customer base.
We, therefore, maintain a modest outlook for gross earnings in 2020FY, with a faster rate of economic recovery and stable regulatory environment as upside risks.
Bottom Line Growth Regains Momentum
ZENITHBANK ‘s H1:2020 bottom-line performance was rather mixed as profits before tax inched up 2.19% to NGN114.12bn. While the significant decline in Cost of Funds (CoF) to 2.20% (vs. 3.00% in H1:2019) led to an expansion in Net Interest Margins to 9.00% (from 8.60% in H1:2019), higher impairment charges were a major drawback to profitability, pushing Cost of Risk (CoR) to 1.80% (vs. 1.40% in H1:2019). Although higher than our earlier expectations, Zenith Bank’s CoR in H1:2020 reflects the impact of the pandemic on risk assets and is consistent with industry trends.
We do not expect a further increase in CoR during the rest of the year as loan recoveries increase with economic recovery.
Thus, we maintain our expectation of lower Cost-to-Income ratio (CIR) in 2020FY, notwithstanding the marginal increase to 54.30% from 53.20% in H1:2019. We are pleased with the moderation in OPEX growth to 7.11% from 10.10% in Q1:2020, despite significantly higher donations to support COVID-19 containment efforts in Q2:2020. The 54.82% YoY decline in taxation significantly boosted after tax profits to NGN103.83bn (+16.81% YoY).
In spite of our modest outlook for revenue, we project a moderately bullish outlook for profits, supported by a further decline in CoF and improved overall cost efficiency.
Mandatory Reserve Debits May Constrain Earnings Growth
The bank has been unrelenting in its quest to grow its assets and retail base, with total assets growth of 19.43% YtD to NGN7.58trn. While we note positively the 11.63% YtD growth in earning assets, the sharp growth (30.56% YtD) in non-earning assets driven by increased mandatory CBN reserves may impair the bank’s future earning capacity. Prudential ratios stayed strong within limits in H1:2020 albeit pressured by the pandemic risk assets growth. Capital adequacy ratio fell 200bps to 20.00%, while asset quality deteriorated to 4.70% from 4.30% in 2019FY.
Based on the bank’s short-term earnings outlook, we revise our expected EPS to NGN6.75 from NGN6.57, and target PE to 2.80x from 2.86x, to obtain a revised December 2020 target price of NGN19.38. This indicates an upside potential of 18.17%, hence we recommend a BUY.