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100608 Nigerian Banks - Let Value Not Liquidity Be King

100608 Nigerian Banks - Let Value Not Liquidity Be King

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Published by: hchan2 on Oct 26, 2010
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Nigerian banks
Let value, not liquidity, be king
Kato Mukuru+234 (01) 448 5385KMukuru@rencap.com
Industry update
Equity research8 June 2010
Report date: 8June2010
Total sector MktCap, $mn 13,639Target MktCap, $mn 24,454Avg. sector P/E Dec 2010E 8.2xAvg. sector P/B Dec 2010E 1.33xAvg. sector P/B Dec 2011E 1.16x
Figure 1: Summary sector ratings and target pricesBanks RatingPrice,NGNTarget price,NGNETR
Access Bank
8.13 17.00 118%Diamond Bank
7.77 15.00 102%Skye Bank
8.29 15.50 95%First Bank
14.32 25.00 83%FCMB
7.76 13.00 75%UBA
11.05 19.00 75%Zenith Bank
13.50 22.00 70%GTB
17.25 28.00 67%
Expected total returnSource: Renaissance Capital estimates
Big bank premium exaggerated.
The big four banks in our Nigerian banksuniverse (First Bank, GTB, UBA and Zenith) trade at a 2010E P/B multiple of 1.46x.This represents a premium of 66% to the tier II banks (Access Bank, Diamond Bank,FCMB and Skye Bank), which are currently trading below their forward book estimate(0.88x). Notably, the 2011 RoAE of the big four banks (29%) does not differ materiallyfrom that of the tier II banks (23%), on our estimates.
Liquidity is king in Nigeria.
In our
opinion, the valuation gap between the big
four banks and tier II banks can primarily be explained by liquidity. Today, the tier IIbanks are trading approximately $0.7mn a day (on average), down from $1.5mn a day(on average) in 2008. Notably, as average daily volumes have fallen 51% since 2008,tier II bank valuations have fallen 49% over the same period (from 1.72x their forwardbook to 0.88x today). Looking at the big four, we would note that their valuations areonly down 29% (from 2.05x their forward book in 2008 to 1.46x today), as daily volumesare down only 25% (from $3.2mn to $2.4mn).
Is big really best in Nigeria?
Although the big four have much higher daily
trading volumes and balance sheets that are almost three times the size of the tier IIbanks on average, is size all that matters in Nigeria? Based on our analysis of theoperating performances of the big four and tier II banks, we believe that there is little to justify the current valuation gaps between the banks. As we show in this note, theoperating ratios of both groups are broadly in line, while the tier II banks enjoy highercapitalisation levels and the big four have better asset quality.
So, why play value now?
We recommend playing value now because we thinkliquidity levels in the Nigerian Stock Exchange (NSE) will continue to improve over2H10 on the back of: 1) lower rates; 2) higher average oil prices and production; 3)resilient deposit growth; and 4) regulatory clarity. What is encouraging is that liquiditylevels over the past month have already begun to improve in some of the tier II banks – most noticeably Skye Bank, which has been trading around $1.2mn a day over the pastmonth. As more tier II banks begin to trade over $1mn a day, we believe their re-ratingwill gather momentum.
Value is our king; we favour the tier II banks.
Based on our estimates,our fair value of these banks, assuming a cost of capital of 17.2% and long-term growthrate of 6%, is 1.50x their forward book value. This would imply 71% upside potential totheir current valuation of 0.88x. With capital risk abating on the back of the forthcomingregulatory changes and volume growth being stimulated by significant liquidity supportfrom CBN (+$3bn) for on-lending to SMEs, the agriculture and infrastructure sectors,the valuation discount being applied to the tier II banks will narrow.
Our top picks among the tier II banks
are Access Bank and Skye Bank. They
are trading at discounts to their forward book values (Access at 0.73x and Skye at 0.96x),despite offering attractive returns in the case of Skye Bank (25% by 2011E) and stronglevels of capital support in the case of Access (Dec 2009 CAR was 32%), in our view.
Figure 3: Sector stock performance – three months
Source: Bloomberg
Figure 2: Price performance – 52 weeks
Source: Bloomberg
   M  a  y  -   0   9   J  u  n  -   0   9   J  u   l  -   0   9   A  u  g  -   0   9   S  e  p  -   0   9   O  c   t  -   0   9   N  o  v  -   0   9   D  e  c  -   0   9   J  a  n  -   1   0   F  e   b  -   1   0   M  a  r  -   1   0   A  p  r  -   1   0
AccessDiamondFBNFCMBGTBUBAImportant disclosures are found at the Disclosures Appendix. Communicated by Renaissance Securities (Cyprus) Limited, regulated by the Cyprus Securities & ExchangeCommission, which together with non-US affiliates operates outside of the USA under the brand name of Renaissance Capital.
8 June 2010 Nigerian banks Renaissance Capital
When we look at our universe of investible bank stocks (i.e. those that passed theCBN/NDIC audit last year) in Nigeria, we see a clear valuation opportunity openingup in the sector.This opportunity favours the four tier II banks (Access Bank, Diamond Bank, FCMBand Skye Bank), which are trading at a significant discount to the sector’s big fourbanks (First Bank, GTB, UBA and Zenith Bank). As shown below, the tier II banksare trading at a 40% discount to the ‘big four’ banks (2010E P/B of 0.88x vs 1.46xfor the big four), despite their weighted average 2011E RoAE being only sevenpercentage points lower (23% vs 29%).
Figure 4: Nigerian banks 2010E P/B multiples vs 2011E RoAEs
Source: Renaissance Capital estimates.
When we estimate the implied fair value multiples of the two banking groups withinthe sector, the attractiveness of the tier II banks becomes more evident. As shownbelow, the estimated fair value multiple of the tier II banks, assuming a cost of equity(CoE) of 17.2% and a long-term growth rate of 6% is 1.50x forward book; 71%above current levels. Although the upside potential in the big four is almost 30 pptslower than that of the tier II, we maintain our
ratings on these stocks becauseof the absolute upside potential (42% on average).
Figure 5: Nigerian banks – fair value multiples vs current (2010E P/B)Current 2011E RoAE(R.H.S)
Fair Value
Premium to2010E P/B current
Nigerian banks 1.33 x 28% 17.20% 6.0% 1.95 x 47%Big four 1.46 x 29% 17.20% 6.0% 2.08 x 42%Tier II 0.88 x 23% 17.20% 6.0% 1.50 x 71%
Source: Renaissance Capital estimates.
Although we are very positive on our universe of investible banking stocks, we donot believe that the current valuation gap between the big four and tier II banks issustainable.We say this because we believe that the current valuation gaps in the sector aredriven primarily by liquidity and not operating performance. In the following twosections, we will explain why we have developed this view.
1.33 x1.46 x0.88 x28%29%23%0%5%10%15%20%25%30%35%0.000.20 x0.40 x0.60 x0.80 x1.00 x1.20 x1.40 x1.60 xNigerian banksBig fourTier II2010E P/B2011E RoAE (R.H.S)
Renaissance Capital Nigerian banks 8 June 2010
Liquidity has become king
In our opinion, liquidity, which is a function of the absolute size of the bank’s balancesheet, has been a key differentiating factor in Nigerian bank valuations. As shownbelow, the big four now trade roughly $2.4mn a day on average (YtD) vs $700,000for the tier II banks. In other words, the big four banks are now trading more than 3xas much as the tier II banks, as shown below.
Figure 6: Nigerian banks average daily volumes, $mn
Source: Bloomberg and Renaissance Capital estimates.
 In 2008, we would note that, although the big four banks traded around 2x as muchas the tier II banks ($3.2mn a day on average vs $1.5mn), the valuation discount ofthe tier II banks to the big four was only 16% (2.05x forward book for the big four vs1.72x forward book for the tier II banks) as shown below. We believe that the lowerdiscount is a function of the tier II banks having crossed the $1mn/day tradingbarrier, which we see as a key liquidity threshold.
Figure 7: Nigerian banks, price/ forward book values
Source: Bloomberg and Renaissance Capital estimates.
 The relationship between bank valuations and liquidity is all the more evident whenone compares the fall in bank valuations over the past two years to the reduction indaily volumes over the same period. As shown below, the forward P/B valuations ofthe big four banks have fallen 29% since 2008 (from 2.05x to 1.46x today), as daily YtDBig fourTier II2.05 x1.23 x1.46 x1.72 x0.76 x0.88 x0.000.50 x1.00 x1.50 x2.00 x2.50 x2008 P/B2009 P/B2010E P/BBig fourTier II

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