MERISTEM EQUITY RESEARCH REPORT ZENITH BANK PLC REPORT DATE: FEBRUARY 23, 2007 RECOMMENDATION: BUY TARGET PRICE: N41.14 EXECUTIVE SUMMARY AND INVESTMENT RATIONALE Zenith Bank Plc was incorporated on 30th of May 1990 as a private limited liability company, commenced operations on July 16, 1990 and became a public liability company on 20th May 2004. It had its Initial Public Offering (IPO) of 800,000,000 shares the same year. It was officially listed on the floor of the Nigerian Stock Exchange on 21st October 2004. In 2006 the Bank s public offer of shares to raise N50billion was oversubscribed and a supplementary listing was done to accommodate additional N3billion raised. The bank offers a wide array of services such as Corporate, Retail and Investment banking, funding of SMEs, Venture capital, Export and Import finance, Bonds, Bankers acceptances, Treasury and other Financial services, Asset Management, Financial Advisory Services, Registrar services and Bureau de Change services The banks investment in technology has positioned it for a wide range of E-business products and solutions for both corporate bodies and Individuals. It also has a competitive advantage in international online retail banking. The Bank is a leading Western Union vendor and operates Zenith Mastercard as part of its affiliation with Mastercard. Zenith bank at present has the widest array of online consumer products available in the Nigerian market. It has various subsidiary holdings namely, Zenith General Insurance Company Limited, Zenith Securities Limited, Zenith Registrars Limited, Zenith Bank Ghana Limited, Zenith Pension Limited, Zenith Trust Limited and Zenith Medicare Limited 1
Zenith Bank is very strong and active in growing loan portfolio among manufacturing companies and multinationals in Nigeria with minimum exposure. It is one of the fourteen local banks approved by the CBN to manage the country s foreign reserves having signed a Memorandum of Understanding (MOU) with JP Morgan Chase for that purpose. Zenith Bank has consistently increased its gross income by not less than 30% and its Profit after Tax by 17% minimum on a year on year basis for the last 5 years. The 5 year average growth rate of income is 45.67% and that of PAT is 37.39%. This is expected to continue as the company explores more opportunities in the market. Zenith has over 180 branches (this is increasing) and has penetrated new markets such as Ghana with the opening of Zenith Bank Ghana. The bank has therefore increased its customer base and is presently enjoying the economies of scale of branch expansion The bank has as its core, its reputable management team. The Managing Director and Deputy Managing Director have been with the bank since inception (co-founders) and are seen as responsible for the bank s reputation as aggressive go getters and have also instilled a culture of professionalism and customer satisfaction. It was rated AA- by Fitch Uk which described Zenith as a strong retail franchise with a stable and growing deposit base with good capital standing supported by consistent profitability and was also rated as the most dominant bank in terms of customer service by KPMG in its 2007 survey of the banking industry. Given the industry sustainable profit potentials from yet to be tapped business opportunities in the country and increasing confidence of depositors in the industry, and its competitive advantage in servicing its captive market in multinationals and local manufacturing companies, Zenith Bank has a very promising future with value adding prospects. We hold a BUY recommendation for Zenith bank given the fact that it is current trading at about 23% discount to its market price. 2
FUTURE FOCUS: Traditionally, the focus of Zenith Bank Plc has been on treasury transactions which have made the bank a major player in the money market. However, as the world becomes more and more technology driven, the bank has channeled resources into E-business services to offer fast, varied and diverse online real time services to meet and surpass the needs of customers. The bank sees E-business as the next frontier capable of creating profits. The bank has its eyes on expanding its role in the financial institutions market. The bank also wants to increase its lending loan portfolio among manufacturing companies and multinationals in Nigeria. Zenith bank wants to expand its funding to Small and Medium Enterprises (SMEs). The bank has also been approved by the CBN as one of the banks to manage the country s foreign reserves. Zenith bank recently signed a Memorandum of Understanding (MOU) with JP Morgan Chase for the management of Nigeria s foreign reserves ANALYSIS OF FINANCIALS Earnings The bank recorded a gross income of N58.22billion for the year ended 2006. This represented about 67% increase in earnings over the N34.91billion recorded in the prior year. This also enhanced Zenith Bank Plc credentials as the third best in terms of gross earnings after First Bank of Nigeria Plc and Union Bank of Nigeria Plc. The company s earnings growth was boosted by interest income with 63% growth recorded from N22.88billion in 2005 to N37.29billion in 2006. Zenith was also successful in diversifying and growing its non interest income as evidenced by a 74% increase from N12.03billion in 2005 to N20.93billion in 2006. Profit after tax (PAT) also grew from N7.15billion to N11.48billion recording 60.55% PAT growth. Income Indices 8 6 4 2 2006 2005 2004 2003 Gross Income Growth PAT Growth Interest Income Growth Non Interest Income Growth 3
Liquidity Zenith Bank Plc s liquidity position improved significantly during the period under review. Its liquid assets to total liabilities ratio increased from 77.29% in prior year to 92.42% in 2006. The banks liquid assets as a percentage of total assets grew from 54.72% in 2005 to 61.06% in 2006. The bank s loans and advances to deposits ratio increased from 40.73% to 54.72% in 2005 before declining to 50.83% in 2006. The increase in deposits by 68% in 2006 signifies customer confidence in the Bank. The decline in loans and advances in 2006 seems to be an attempt to meet the growing level of activities from demand depositors and supported by a marginal decline in interest income from 65.55% in 2005 to 64.06% in 2006. The bank liquidity position was boosted through fresh funds inflow during the public offer of 2006. This has really helped its operating position and has minimized the risk of defaults in terms of deposit demand by customers. ANALYSIS OF LOAN TRENDS 35 30 25 20 15 10 5 2006 2005 2004 2003 2002 Loan Growth Loans/Assets Loans/Equity Asset Quality Zenith Bank Plc witnessed exceptional growth in its asset base. It recorded N608.5 billion in 2006, an increase of 85.44% over N329.7billion recorded in 2005. The bank maintained very good asset quality with minimum doubtful, lost and substandard loans through a very strong and robust risk management structure put in place. From the review of its financials, over 98.87% of loans and advances were performing with about 1.13% being doubtful or lost. This is virtually the same position as the previous year indices. The non performing loans as a percentage of shareholders funds dropped from 5.52% in 2005 to 2.46% in 2006. The loan loss provision as a percentage of total loans dropped from 2.28% in 2005 to 2.04% in 2006. It is most interesting and commendable on the part of the bank that despite the strict risk 4
management structure put in place, nevertheless interest income increased by 63% during the period under review. Capital Adequacy The shareholders funds of the Bank grew from N37.78billion in 2005 to N93.8billion in 2006. This was due mainly to the company s Public offer of shares in 2006 in which 3.17billion shares were issued and N53billion was raised. Tier 1 capital to risk weighted assets ratio was 57.04% in 2006. The ratio of risk weighted assets to total assets dropped from 35.69% in 2005 to 27.03% in 2006. Collectively, these ratios show that the bank is well positioned to absorb losses or defaults on its risky assets such as loans and advances. This is also attributed to the rise in shareholder funds due to the 2006 public offer of shares. CAPITALISATION RATIO 15.00% 1 5.00% 2006 2005 2004 2003 2002 CAPITALISATION RATIO Profitability Profitability ratios for Zenith Bank Plc have been quite impressive though there is need for further improvement in key ratios. The Bank s spread, which is the difference between the yield on average earning asset and cost of interest bearing liabilities increased marginally by 0.3% to 9% while the bank s Net Interest Margin which is the relationship between the net interest incomes over average earning asset declined marginally. Efficiency ratio on the other hand, which measures a bank s ability to control non interest expense relative to adjusted operating income (Non interest expense/nii+non interest Income) has been on a marginal decline from 69% in 2004 and 2005 to 68% in 2006. A large bank is expected to maintain 55% of this ratio and Zenith should work towards this. In the same vein, the bank s burden ratio, which measures the amount of non interest expenses covered by non interest income as a fraction of average total assets has however been on the decline. The lower this ratio, 5
the lower the extent to which non interest expenses is greater than non interest income. For Zenith Bank, the ratio has been consistently declining from 3.9% in 2004 to 2.49% in 2006 which shows improvement in non interest income of the company. It is expected that the bank will work more on this to further reduce the burden on the net interest income. The operating expenses to gross earnings ratio which was 57.65% in 2004, declined to 52.02% in 2005 and rose again to 53.76% in 2006. Though the proportion of operating expenses to earnings increased, earnings growth has been strong and has far outweighed the increasing costs ensuring that Zenith Bank Plc remains profitable. The bank also faces declining net interest margins. Net interest margin was 73.18% in 2003, 71.67% in 2004, 49.45% in 2005 and 46.05% in 2006. The same trend was also observed for profit after tax to gross income ratio which was 28.91% in 2002, 24.79% in 2003, 21.69% in 2004, 20.47% in 2005 and 19.73% in 2006. Zenith Banks return on equity (ROE) and return on assets (ROA) have dwindled. ROE declined from 36.75% in 2002 to 34.35% in 2003 and 33.12% in 2004 with further decline a lower levels of 18.19% and 12.25% in 2005 and 2006 respectively. ROA however nose dived from 3.93% in 2003 to 2.69% in 2004, 2.17% in 2005 and 1.89% in 2006. An explanation of this decline is the growth of the company s shareholders funds due to injection of new funds thereby increasing the bank s asset base. Despite this the bank was still able to maintain its profit level and paid a dividend of N1.10k per share amounting to N6.6billion dividend payment. PROFITABILITY TRENDS 4 35.00% 3 25.00% 2 15.00% 1 5.00% 2006 2005 2004 2003 2002 Return on Assets Return On Equity PAT/Earnings 6
Q2 2006 Results and Company prospects The bank recently released its Q2 2006/2007 half year results and the trend of consistent earnings growth was maintained as the gross income rose to N40.49billion from N26.35billion in the corresponding period prior year representing a growth of 53.66%, PAT grew by 62% from N5.15billion to N8.36billion. The bank has posted the second highest PAT for Q2 2006 overtaking Union Bank Plc which recorded N8.26billion for the same period and closely trailing First Bank Plc which posted N10.2billion. Zenith Bank Plc has shown itself to be consistent in performance. The bank has surpassed its initial estimate for PAT in its 2006 offer document where it forecasted N9.16billion for the financial year but achieved N11.48billion. The Bank forecasted N12.91billion PAT for its financial year end June 2007 and given a PAT of N8.36billion for its half year ended December 2006, the bank looks well on its way to surpassing that estimate. RISK ANALYSIS The increasing keen competition among banks and growing strategic alliances between local and strong foreign private equity investors constitute a challenge to Zenith bank. Continued competition reduces share of industry margin and thus compels the bank to seek more opportunities in non interest based banking income. In the same vein, the growing need to increase interest income through more credit exposures may be another risk. Though the bank seems poised to tackle this challenge, more efforts need be deployed towards strengthening the existing risk control measure of the bank. The possibility of increasing the proportion of capital to risk weighted assets to meet industry business growth with increasing credit exposure. In the same vein, political and regulatory risk may have a limiting effect on profit projections and return to ordinary shareholders. BALANCE SHEET INDICES 15 10 5 2006 2005 2004 2003 SHF Grow th Deposit Grow th Asset Grow th 7
CAPITAL & OPERATIONAL MARGINS 10 8 6 4 2 2006 2005 2004 2003 2002 Net Interest Margin Operating Marging Tier 1 Capital VALUATION In determining an appropriate value for Zenith Bank, we have employed a number of valuation metrics ranging from the Discounted Cash Flow (DCF) Valuation metric and other relative valuation metrics. We employed a residual income approach and estimate that return on equity (ROE) will grow to 20% in 2007, 21% in 2008 and 23% between 2009 and 2011 before maintaining an average growth of 20% thereafter. We estimate that PAT will grow by 19% and 14% in 2008 and 2009 before maintaining an annual growth of 10% into perpetuity. We expect the cost of equity to decline in the next five years due to the bank s growth and expansion. Based on the above assumption, we estimate that Zenith should have an intrinsic value of N32.88. However, using a trailing P/E with a forecasted EPS of N1.92, we believe the bank should be valued N40.32, while using the industry average P/E of 21.79, the stock price should be trading at N41.83. With our Price/Gross Earnings (P/GE) valuation figure of N32.02, Price/Book Value (P/B) of N55.51 and given an appropriate weight to each of the valuation ratios, we are more overweight on the DCF and P/B as a better relative valuation measure of bank s value. We therefore believe that the bank is currently trading at a discount of about 23%. 8
INDICES ZENITH INDUSTRY AVRG. REMARKS Mkt. Capt. (N bn) 309.53 277.08 GOOD Shares Outstanding (bn ) 9.27 9.47 GOOD Shareholders' Funds- (N'bn)* 93.80 61.95 EXCELLENT Gross Earnings Growth Rate % (CAGR) 48.05 25.76 EXCELLENT PAT Growth Rate % (CAGR) 34.56 33.13 GOOD Asset Quality ratio (NPL/TL) % 1.13 9.16 VERY GOOD Capitalisation Ratio (Equity/TA) % 15.41 12.13 GOOD Efficiency Ratio (Texp/GE)% 74.10 72.93 GOOD Return on Equity (ROE) % 17.11 20.52 BELOW AVG Return On Assets (ROA) % 2.49 2.79 BELOW AVG EPS (k) 159.00 135.00 VERY GOOD DPS (k) 110 76.17 VERY GOOD P/E 21.00 21.92 GOOD Earnings Yield (%) 4.76% 4.60% GOOD Stock Volatility (β) 0.84 0.77 NORMAL ZENITH BANK PLC: TRENDS IN STOCK PRICE MOVEMENT JANUARY 2006-FEBRUARY 2007. 40.00 35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00 3-Jan 17-Jan 31-Jan 14-Feb 28-Feb 14-Mar 28-Mar 11-Apr 25-Apr 9-May 23-May 6-Jun 20-Jun 4-Jul 18-Jul 1-Aug 15-Aug 29-Aug 12-Sep 26-Sep 10-Oct 24-Oct 7-Nov 21-Nov 5-Dec 19-Dec 2-Jan 16-Jan Meristem Securities Limited EQUITY RESEARCH REPORT and its attendant recommendations are prepared based on publicly available information and are meant for general informative purposes. Meristem Securities Limited can neither guarantee the accuracy or completeness of the information as they are an expression of our analysts views and opinions. Meristem Securities Limited cannot be held responsible for any loss suffered by relying on the said information as this information as earlier stated is based on estimates and opinions and is meant for general information purposes and not as solicitation to buy securities and financial instrument. Meristem Securities Limited 9 30-Jan 13-Feb