Zenith Bank Shares Rated Buy amidst Concern over Earnings Quality
Zenith International Bank Plc bolstered earnings performance in the first half of 2020 amidst global outbreak of coronavirus pandemic that has infected Nigeria’s fragile economy.
While lender’s reported improved profit performance, analysts expressed concerns over quality of earnings driven by regulatory advantages.
Analysts at Meristem Securities expressed concern that gains from trading assets and foreign excnage revaluations remained the key drivers of topline performance in spite of the bank’s robust earning assets base.
The earnings is not sustainable, analysts explained citing volatile regulatory environment.
The leading Tier-1 capital bank earnings from interest yielding assets came stronger compare to reported figure in the first quarter.
In its equity note, Meristem Securities Limited said in that lender’s non-core earnings continue to support top line as interest income rebounded strongly at 11.40% in Q2:2020, after suffering a 6.65% decline in Q1:2020.
This culminated in a 1.10% year on year growth in interest income to ₦216.95 billion in the first half of the year, backed by the bank’s considerable asset growth over the period.
However, Meristem Securities noted that the current low yield environment continues to weigh heavily on the 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 COVID-19 pandemic during the period as net fee and commission income declined by 39.97% year on year to ₦33.50 billion.
“We are concerned that gains from trading assets and FX revaluations remained the key drivers of topline performance in spite of the 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”, Meristem explained.
Equity analysts stressed that this development is not encouraging in view of the heightened instability in the regulatory environment.
On a positive note, analysts recognised that the bank’s increased spending on information technology may translate to increased transaction volumes across digital platforms given its robust customer base.
Meristem Securities therefore said the firm maintains a modest outlook for gross earnings in 2020, with faster rate of economic recovery and stable regulatory environment as upside risks.
Bottom Line Growth Regains Momentum
Zenith Bank ‘s H1:2020 bottom line performance was rather mixed as profits before tax inched up 2.19% to ₦114.12 billion.
While the significant decline in Cost of Funds to 2.20% from 3% in H1:2019 led to an expansion in net interest margins to 9% (from 8.60% in H1:2019), higher impairment charges were a major drawback to profitability, pushing Cost of Risk (CoR) to 1.80%, 40 basis points above 1.40% in H1:2019.
“Although higher than our earlier expectations, the 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 2020, notwithstanding the marginal increase to 54.30% from 53.20% in H1:2019”, Meristem Securities stated.
Meanwhile, the moderation in operating expenses (OPEX) growth to 7.11% from 10.10% in Q1:2020, despite significantly higher donations to support COVID-19 containment efforts in Q2:2020 excite Meristem analysts.
Analysts said the 54.82% year on year decline in taxation significantly boosted after tax profits to ₦103.83 billion, up 16.81%.
“In spite of our modest outlook for revenue, we project a moderately bullish outlook for profits, supported by further decline in CoF and improved overall cost efficiency”, Meristem said.
Mandatory Reserve Debits May Constrain Earnings Growth
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According to Meristem, Zenith bank has been unrelenting in its quest to grow its assets and retail base, with total assets growth of 19.43% year to date to ₦7.58 trillion.
“While we note positively the 11.63% year to date 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”, Meristem noted.
Analysts however explained that prudential ratios stayed strong within limits in H1:2020 albeit pressured by the pandemic risk assets growth.
Specifically, Lender’s capital adequacy ratio fell 200 bps to 20%, while asset quality deteriorated to 4.70% from 4.30% in 2019.
Meristem explained that based on the bank’s short-term earnings outlook, it has revised expected earnings per share to ₦6.75 from ₦6.57, and target price earnings to 2.80x from 2.86x.
Analysts forecast a revised December 2020 target price of ₦19.38, which indicates an upside potential of 18.17%, hence the BUY rating.
Zenith Bank Shares Rated Buy amidst Concern over Earnings Quality
