Zenith Bank Plc. (Zenith) released audited H1 2017 result with its numbers showing a two-fold YoY increase in EPS to N2.40 largely supported by surprise FX trading income and FX revaluation gains. In addition, the bank declared an interim dividend of 25kobo— unchanged from last year—which translates to a dividend yield of 1.0% on current pricing.
Despite the impressive earnings, breakdown showed sizable decline in core performance with Net Interest margin (NIM) contracting 56bps YoY following substantial funding cost pressure (WACF: +310bps YoY to 6.3%).
Furthermore, loan loss provision was 3x higher relative to prior year at N42billion, reflecting higher specific and collective provision (Cost of Risk: +263bps YoY to 3.9%).
Excluding the outsized FX trading income (N46billion) and FX revaluation gains (N15billion), H1 17 EPS would have declined 60% YoY, although adjusting for similar Cost of Risk as with prior period (1.2%), EPS would have risen by 20% YoY.
Derivative gains to NIR masks soft core earnings
As earlier stated, Zenith’s results owed much to gains on currency forward positions of N69.5billion (derivative assets and liabilities of N82.1billion and N17.2billion respectively).
We believe the change in the reporting of forward contracts from NIFEX to NAFEX in April 2017, which embodied a 16% gain helped Zenith book gains on existing counter-party forward contracts.
Furthermore, Zenith’s small net long USD position helped book revaluation gains of N4billion (+202% QoQ) in the quarter. Consequently, the Q2 17 reading from FX gains bolstered NIR (+199% QoQ to N88.5billion) over the quarter.
Funding cost pressure moderates NIMs
As earlier stated, core performance remains weak for Zenith. The bank continues to suffer under the elevated interest rate environment despite its liquid balance sheet position which allowed it benefit from high treasury bill income (20% QoQ) and upward loan repricing (interest income on loans: 27% QoQ).
Basically, while asset yields expanded 200bps QoQ, NIM came in lower (30bps QoQ) at 6.7%. The pressure, which emanated from higher term-deposit cost (82% QoQ), drove funding cost pressures with annualised WACF expanding 260bps QoQ to 7.6%. We will be seeking further clarity from management on the increase in term deposit given that term-deposit declined 3% QoQ while CASA’s share of deposit was flat at 61%.
Asset quality issues persists
Asset quality deteriorated over the quarter with NPL ratio rising to 4.3% (Q1 17: 3.2%). Breakdowns provided by Zenith throws up increases in Transport (34x YoY) and General commerce (1x YoY) as the main triggers of the higher NPLs even as NPL to O&G remained sticky (2.3% YoY).
Given the 12x and 1.4x increases in specific impairment to Transport and General commerce sector respectively, we are now more concerned on asset quality which we think are related to key loans in the aviation and trade sectors.
We will also seek further clarity from management on the specifics to guide our revision to forecast. On balance, loan loss provision expanded nearly four-fold QoQ to N34.5billion with annualized Cost of Risk trending higher to 6.3% (+500bps QoQ).
Further down, operating expenses increased 54% QoQ despite declines in personnel cost (-70bps QoQ). Pertinently, AMCON’s levy, which expanded 200% QoQ to N16billion, drove operating cost pressure in the period. That said, the impact of strong NIR was able to offset elevated cost marginally to leave Cost-Income ratio at 47% (-60bps QoQ).
Overall, despite higher gross earnings (24% QoQ), funding cost pressure and elevated expenses moderated potential pass-through to EPS (+90bps QoQ to N1.20). ROAE stayed flat relative to prior quarter at 21.5% (Q2 16: 5.7%).
Muted prospects for higher NIR
We forecast FY 17E WACF at 5.2% (2016: 4.2%), largely reflecting expected pressures from term deposit and borrowings. The foregoing brings FY 17E interest expense to N202.5billion (+40% YoY). Laying our funding cost assumption with FY 17E asset yield of 10.9% (interest income: 33% YoY to N513billion), we now expect NIM to come in at 6.6%.
On NIR, given our views on improved dollar liquidity, we think the bank will be unable to secure further forward contracts from counter-party. The impact of this, alongside our expectation of stable-to-slight fall in the NGNUSD, guides to limited scope for FX income from its derivative position in coming periods.
Thus, despite expected gains from treasury bills as well as net fee income (+5.7% YoY to N72billion, we forecast NIR at N135billion for FY 17E (+10% YoY). Furthermore, given asset quality concerns stated earlier, we forecast 2017E NPL and Cost of Risk at 4.0% (2016: 3%) and 2.7% (2016: 1.4%) respectively, which translates to impairment charge of N68billion.
In all, we forecast FY 17E EPS of N4.95 (+20% YoY). Our FVE of N27.30 translates to an overweight rating on the company. The stock trades at a P/B of 1.1x relative to peer average of 0.9x.