STOCK UPDATE OPINIONN. May 55 BUY RO RO % VARIANCE COMPANY UPDATE. - Research. cheaper. indicate. sustainable.

Transcription

1 INVESTMENT RESEARC CH INVESTMENT RESEA NATIONAL FINANCE COMPAN NY SAOG (.MSM) National stands out in its sector as one of only three companies with superior earnings quality and a significantly improved quality of assets. It is likely to benefit from improving net interest spreads due to cheaper access to funds, while its net finance debtors grow with improving demand for credit and an increasee in equity capital. RECOMMENDATIONN : BUY CMP (4MAY2011) TARGETT PRICE VARIANCE : : : RO RO % COMPANY UPDATE INVESTMENT OPINIONN STOCK UPDATE May 5, 2011 National Company s () recent financial performance echos a key trend among NBFC companies in Oman, i.e., improving net interest spreads driven by cheaper cost of funding besidess growth in finance leases and working capital loans. With ample liquidity in the banking system, banks have been more liberal in lending to the NBFC industry and current low interest rates correlated to the US Fed rate indicate that the trend is likely to extend through While this trend also benefits other companies in the NBFC sector, our analysis of the sector suggests that only three players may offer a superior quality of earnings and asset portfolio to provide investors with sustainable returns going forward. ANALYSTS ANALYST Anil Kumar, CFA Anil Senior Kumar, VP - Researc CFA ch Sr. Vice anilkumar@f President - fincorp.org Research Tel: (+968) anilkumar@f May 55 fincorp.org Ext. 15, 340 Tel: (+968) Ext Gaurav Ramaiya Gaurav Asst. Vice Ramaiya President - Research Asst. Vice gaurav@finc President corp.org - Research Tel: (+968) gaurav@finc corp.org 55 Ext. 320 Tel: (+968) Ext. 320 s signficantly improved asset quality and adequatee coverage of impaired assets put it in a good position along with Al Omaniya Financial Services () and Oman Orix Leasing () to sustain its earnings growth. We value using a relative P/BV multiple comparision to other finance company stocks and a fair P/BV multiple based on our expectation of its sustainable longterm on these two ROE, cost of equity and longterm growth rate in earnings. Based approaches, we arrive at a fair value of RO for the stock. Mable Pereira Asst. Vice President - Research mable@fincorp.org Tel: (+968) Ext. 323

2 Q FINANCIAL PERFORMANCE reported a positive performance in Q with net profit higher by 53.3% YoY at RO 0.64 million, while net finance income rose 33.3% YoYY at RO 1.52 million. Interest costss were lower as it retired a significant portion of its corporate deposits and replaced them with shortterm borrowings. On a QoQ basis, net profit showed a 21.7% decline primarily due to a higher level of provision in the quarterr as the company increased its provision coverage for impaired assets. (RO'000) Net finance income Total operating income Net operating profit Net profit Financial Performance Q Q ,,522 1,,708 1,, Q ,142 1, YoY % 33.3% 30.4% 48.3% 53.3% Q ,432 1,562 1, QoQ % 6.3% 9.3% 2.2% 21.7% Net finance debtors 86,133 69,640 Impairment provisions 5,,362 4,644 Nonperforming assets (NPA's) 5,,930 4, % 15.5% 19.6% 80,076 4,953 5, % 8.3% 0.5% Net interest spread Net interest margin Impaired assets ratio Coverage ratio 5.9% 7.1% 6.5% 90.4% 4.6% 6.6% 6.7% 93.6% 5.8% 7.2% 6.9% 83.9% Source: Company Financial Statements Net interest spread improved to 5.9% in Q compared to 4.6% in Q and 5.8% in Q4 2010, while net interest margin improved to 7.1% compared to 6.6% in Q1 2010, but declined marginally compared to 7.2% in Q The company has started a new business segment of working capital financing, which has a lower margin than its existing business segments but with lower risks. Net finance debtors reported a growth of 7. 6% QoQ to RO 86.1 million, while the company s impaired assets increased marginally by 0.5% to RO 5.93 million. The company s impaired assetss ratio declined to 6.5% from 6.9% in Q4 2010, while impaired assets coverage ratio rose to 90.4% against 83.9% in Q

3 HISTORICAL FINANCIAL PERFORMANCE VS. PEERS Financial results of the latest two quarters of NBFC companies in Oman point at a robust YoY growth in net finance income driven by cheaper cost of funding and growth in net finance leases and working capital loans. Currently there is ample liquidity in the banking system and repo rates are not expected to rise in 2011 tracking movement in the US Fed rate. Banks are now more liberal in lending to the NBFC industry driving their cost of funds lower. Some of the companies have started to take advantage of this trend by replacing their more expensivee corporate deposits with bank borrowings thereby improving their net interest spread. Average net interest spread improved to 4.8% in 2010 from 4.0% in % Figure 1: Trend of Net Interest Spread for vs. Peers 1 8.0% 6.0% 4.0% 2.0% FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 Source: Company financial statements, P Investment Research During the past five years, Muscat () has led the NBFC peer group by net interest spread and net interest margin followed by Taageer (). In FY 2010, earned a net interest spread of 5.9% followed by at 5.5%. Like wise, NIM of Muscat and Taageer were 7.8% and 7.5% respectively in against a group averagee of 6.8%. 3

4 12.0% Figure 2: Trend of Net Interest Margin for vs. Peers 1 8.0% 6.0% 4.0% 2.0% FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 Source: Company financial statements, P Investment Research The charts above suggests a likely inflection point in the industry s NIM in FY The nearterm impact of greater Omanisation and increase in minimum wages for Omanis is expected to be moderate on the earnings of finance companies as their net finance income is expected to post a robust growth. According to industry sources, a higher staff cost can be easily absorbed in the mediumterm. Risk of higher provisions for companies that have not adequately covered their impaired assets is more worrying than wage hike. All the finance companies have been substantially raising their equity capital since 2010 in order to comply with the CBO s directive to achieve a minimum share capital of RO 20 million by June A better capitalization enables further growth in net finance debtors in the quarters ahead. Most finance companies including National currently have a net worth of around RO 21 million and the CBO rules allow a leveragee of 5.0x networth for finance companies implying a potential size of finance debtors of RO 105 million. National gross finance debtors are currently around RO 91.5 million and hence a 15% asset growth is possible by the end of In terms of asset quality, Muscat and Taageer have seen a notable deterioration at the end of FY 2010 as seen by a sharp rise in their impaired asset ratio in Fig 3 below. National has seen a significant improvement in the quality of its assets from 29.3% in FY 2005 to 6.5% as of Q

5 35.0% Figure 3: Trend of Impaired Assets Ratio for vs. Peers % % 1 5.0% FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 Source: Company financial statements, P Investment Research Impaired asset coverage ratio also slipped substantially for and to 55.5% and 50% respectively at the end of 2010 as they have not increased provisions proportionate to growth in their impaired assets. This poses a risk of a sharp increase in net provisions for these two companies going forward if recoveries don t turn out to be strong. 60 Figure 4: Trend of Coverage Ratio for vs. Peers FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 Source: Company financial statements, P Investment Research In terms of asset coverage ratio, Al Omaniya Financial Services leads the industry at 240% and its earnings are therefore of superior quality as compared to the other players. Oman Orix Leasing and National also have made adequate provisons for their impaired assets at 105% and 90% respectively. 5

6 INDUSTRY ANALYSISS Oman s NBFC industry is moderately concentrated and evenly distributed: National () is the third largest NonBanking Company (NBFC) in Oman by net finance debtors (RO 86.1 mn as on Mar 31, 2011). The company enjoys a 16% market share in Oman s RO 502 million NBFC industry (by net finance debtors) in close competition with players like Muscat and Taageer. Figure 5: Market share by net finance debtors (Dec 31, 2010) United 14% Oman Orix Leasing Co 12% Muscat 16% National 16% Taageer 16% Al Omaniya Financial Services 26% Source: Company financial statements, P Investment Research tops its peer group in terms of 5 year average ROE at 16.9% but the same trend may not hold owing to a signficant increasee in capital and a slower growth in finance debtors compared to. Our study on Oman s NBFC industry reveals that all the six listed players currently operate with only one business segment, i.e. financing and it is difficult to sustain a ROE of more than 17% through financing alone unless a firm adopts a loose lending policy taking huge credit risks. During bad times, such loose lending policies can severely damage a firm as seen in the case of erstwhile market leader, United. Figure 6: Five year average ROE 18.0% 16.0% 14.0% 12.0% 1 8.0% 6.0% 4.0% 2.0% Muscat Al Omaniya Financial Services Oman Orix Leasing Co Taageer National United 6

7 Figure 7: Leasing portfolio and finance income growth in Oman's leasing sector ( ) % % 1 5.0% Net finance debtors (5yr CAGR) Net finance income (5yr CAGR) Source: Company financial statements, P Investment Research VALUATION We value using 1) P/BV multiple comparision to other finance company stocks and 2) by estimating a fair P/BV multiple for it based on our expectation of its sustainable longterm ROE, cost of equity and longtwo term growth rate in earnings. We arrive at a fair value of RO for the stock based on these methods. Relativee Valuation Valuation of NBFC companies can be compared based on P/BV multiple whichh also reflects their ability to sustain a particular level of ROE in the medium to longterm. an attractive P/BV band for stock accumulation. A historical study of P/BV range over the past five years for these firms also aids in determining Company Muscat Al Omaniya Taageer Last Reported BVPS (RO) Net worth (Q1 2011) (RO'mn) National United Oman Orix Peer group average Source: Company financial statements and P Research 2010 stock Dividend 12% 7% conv bonds 12% 16% 0% 25% Nearterm proposed capital raise RO 4 mn rights issue at par Outstanding Expected Stock price P/BV (post shares (mn) BVPS (RO) (RO) dilution)

8 Figure 8: National P/BV ValuationBand P/BV High P/BV Low Current P/BV Source: Company financial statements, P Investment Research As shown in the table above, the mean P/BV of the sector is 1.00x after adjusting the reported book values for capital raise and stock dividends distrbuted in Considering the improved asset quality and adequate provisioning of the company, we believe thatt National deserves a premium to the average sector multiple. We assign a P/BV of 1.2x but lower than for. The fair value for works out to RO Table 2: Expected Dividend Yield 3.7% 7.2% 4.4% 3.5% Justified P/BV Valuation (Gordon Growth Method) This valuation is based on a fair P/BV multiple of 1.13x based on the Gordon Growth Model as shown below, applied to the Q book value for of RO per share: Formula: Justified P/BV = (ROE g)/(k g) Sustainable earnings growth rate, g = 4. 0% Current implied cost of equity, k = 11.0% Sustainable ROE = 12.0% Fair P/BV = (12% 3%) / (11%3%)= 1.14x Current book value per share = RO Fair value for stock = 1.13 x RO = RO Based on the above two methods, our target price for is RO per share (average of RO and RO 0.137). 8

9 Anil Kumar, CAIA Gaurav Ramaiya Mable C Pereira INVESTMENT RESEA CONTACT DETAILS (+968) Ext: 340 anilkumar@fincorp..org (+968) Ext: 320 gaurav@fincorp.org (+968) Ext: 323 mable@fincorp.org Deena Omeir Mohammed Al Ghalayini Halima Al Mahrooqi Riyadh Albawi BROKERAGE CONTACT DETAILS (+968) Ext: 335 (+968) Ext: 333 mohammad@fincorpinv.org (+968) Ext: 305 (+968) Ext: 337 org Disclaimer The research team of The Financial Corporation, SAOG (hereto referred as P) has prepared the information, analysis and expressed its opinion on the subject matter of this report. The information contained has been obtained from sources believed to be reliable and in good faith, but which may not be verified independently. While utmost care has been taken in preparing the above report, P makes no guarantee, representation or warranty, whether express or implied, and accepts no responsibility or liability as to its accuracy or completeness of the data, being provided. All investment information and opinions are subject to change without notice. The investor will indemnify P and its directors, officers, and employees against any loss or damage or other liabilities (including costs), which they may suffer as a result of reliance on this report. This report is not to be relied upon in substitution for the exercise of independent judgment. Also, not all customers may receive the material at the same time. This document is for private circulation and information purposes only. It does not and should not be construed as an offer to buy or sell securities mentioned herein. P will not be liable for any direct or indirect losses arising from the use thereof, and the investors are expected to use the information contained herein at their own risk. P and its affiliates or their officers, directors and employees may own or have positions in any investment mentioned herein or any investment related thereto and from time to time add to or dispose of any such investment. P and its affiliates may act as market maker or assume an underwriting position in the securities of banking companies discussed herein (or investments related thereto), and may sell them to or buy them from customers on a principal basis and may also perform or seek to perform investment banking or underwriting servicess for or relating to those banking companies. Authors or contributors of this report could have direct interest in the capital market or in the securitiess mentioned herein. The investments discussed or recommended in this report may not be suitable for all investors. Investors must make their own investment decisions based on their specific investment objectives and financial position, and using such independent advisors, as they believe necessary. Income from investmentss may fluctuate. The price or value of the investments, to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. This document is strictly for the use of recipients only. None of the material provided herein may be reproduced, rewritten, rehashed, published, resold or distributed in any manner whatsoever without the prior and explicit written permission of P. 9