abil_reiterate our sell_improving but lags our expectations

8/8/2019 ABIL_Reiterate Our SELL_Improving but Lags Our Expectations

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ABIL

Earnings miss our forecast, FY11 PT

shows no upside; reiterate our SELL

Background: ABIL released its reviewed financial resultsfor the 12-month up to September 2010. While there are

improvements, we are disappointed overall and we reduce

our forecasts for FY11 and FY12. It looks (to us) as if

opportunities for ABIL are increasingly becoming difficult to

exploit and maybe dwindling. But again, management gives

a clear strategy as to what they will implement next year,

and we become, to an extent, caught in between the reality

as represented by the numbers and managements positive

outlook. What we missed and what was in line: Gross margin on

retail came out at R1.974bn (estimate: R2.2bn), a growth

of 10%. Net assurance income of R1.6bn underperformed

our forecast of R1.7bn. Interest income from advances was

in line with our forecasts at R5.950bn (estimate 5.949bn),

despite our lower estimate of the advances (R22.6bn vs.

actual of R25.4bn). Non-interest income also came in line at

R2.491bn versus our R2.501bn forecast. Interest expense

was slightly higher at R2.383bn against our forecast of

R2.149bn due to higher funding. Operating costs of

R4.481bn lagged our forecast of R4.878bn, thanks to

efficiency benefits and cost cutting. Profit from operationswas slightly lower at R2.828bn versus our expectations of

R2.880bn and the profit before tax compares favourably at

R2.862bn against our estimate of R2.880bn. Profit after tax

underperformed our projections by 3.8% at R1.942bn

versus R2.016bn.

African banks ROA decline but we are not surprised:Managements ROA target of 8% which we have highlighted

as an aggressive assumption, seems to move further out as

the ROA declined to 5.7% from 7.7% for FY09. In our view,

an ROA range between 4% and 6% would be more

achievable given 1) competition development in the sector

2) ABILs non-deposit taking strategy that reduces

opportunities of augmenting fee income from the liability

side of its balance sheet. As we had anticipated, leverage

increased to 7.8X to support ROE at >40%.

We maintain our SELL: There are immaterial changes toour price target, and at the current price, the risk return

profile is not attractive. SELL.

Peter MushangweLawrence Madzwara+27 11 551 3675

[email protected]

November 22, 2010 Equity Report

FY11 PT R32.7

SELL


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Page 1 of 7

We shall issue a more detailed report post discussions with ABILs

management. In this report we highlight salient features of the results

and reiterate our SELL recommendation.

African bank; yields falling faster: The flagship of the Groupwitnessed a more positive 2H10, but headline earnings were lower

by 1% to R1.541bn. Net assurance income declined by 20% to

R998mn while bad debts went up to R2.2bn from R1.93bn despite

a moderation in the bad debts/advances ratio. The banks ROE

declined to 5.7% against a management target of 8% (which we

believe is aggressive) while leverage increased to 7.8X to support

ROE at >40%. African banks yield continues to decline, losing a

further 3 percentage points to 35% (see Fig 1).

Ellerines; recovering but some way to go: The EllerinesHolding Limited business unit continue to show recovery as

earnings bounced by 35%. This is obviously a positive

performance, but in our view, the top line growth of 10% shows a

slower than anticipated recovery, especially provided the possible

once-off effect of the WC2010. This is not to downplay a 10%

revenue growth, but in light of the share price, it looks to us as if

the market expected more. (see valuation section for a discussion

on valuation).

The CAMEL analysis shows a mixed picture. Key issues are:

Capital: The Groups internal capital management model indicatesan optimal capital/Risk Weighted Assets (RWA) of 26.3% i.e.

R7.1bn in capital. The Group has a capital base of R8.7bn (32.2%

of RWA), thus providing it with room to further expand its loan

book without capital constraints at Group level. However, African

banks CAR is 28.9%, which provides a buffer of 4.4pp to the

SARBs minimum requirement of 24.5% for ABIL and African bank.

Management highlighted a transaction that would result in capital

of R300mn moving to African bank. Given the strategy to take

more risks, we believe it is necessary to increase the buffer

against the minimum required.

Asset growth and quality: The loan book expanded by 24% toR25.360bn, with number of loans written increasing by 3%. Thecredit card portfolio continues to show a pleasing growth rate of

49%, increasing to R1.467bn. The average loan size increases to

R8,224 from R6,719 while the average tenor lengthened to 42

months from 33 month last year. Short-term deposits and cash

declined slightly to R3.4bn. The cash raised is yet to be utilised.


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Page 2 of 7

Asset quality improved on 1) the migration to lower risk client base

2) improved customer management and credit granting system

and 3) improving economic conditions and outlook. Baddebts/Advances ratio seems to be moderating, reducing to 9.4%

from 10.4% in FY09. Having said that, the ratio is still higher than

the pre-2007 level. NPL coverage ratio at 63% is reasonable in our

view, notwithstanding the deterioration. (see Fig 2).

Management/ Efficiency: Management has done well with costmanagement. Operating costs declined from R4.576bn to

R4.481bn. Ellerines registered a 5% reduction in operating costs

while African bank saw an increase in cost by 6%. The migration of

Ellerines Financial Services to African bank is improving asset

quality and offer rate which resulted in the approval rate

increasing to 72% from 66%. Sales for Ellerines are also improving

along with the gross profit which improved to 44.9% (vs. our

estimate of 43.5%). Productivity indicators, mainly sales per

employee show improvements as the 12month rolling

sales/employee ratio increased by 26.1% when compared to

August 2009 level. Managements FY11 targets are to 1) grow

merchandise sales by >8.5% 2) grow advances by >25% and 3)

record an ROE of >18.5%.

Earnings: The Group ROE improved slightly to 15.6% from 15.2%for FY09. The economic profit calculated by management using a

CoE of 15% recovered to R78mn from a negative R95mn last year.

The key issue is that the yield for African Bank is falling, having

declined from 54.6% in FY05 to 34.5% in FY10. This is notsurprising given 1) the migration to lower risk segment (higher

loan value, longer tenors at lower yields); 2) the higher insurance

claims as the economy is yet to gain traction on employment; and

3) the NPLs that remain elevated as unemployment remain

stubborn. For us the key question is whether African bank, which

has been supportive of the Groups ROE can continue to lever its

balance sheet given the non-deposit taking strategy. We do not

see the banks ROA reaching the 8% target in the short term

despite managements ability to manage costs. Asset yield

contraction is going to continue to put pressure on ROA, and

opportunities to lever the balance sheet further look diminished.

Remember managements target leverage ratio was 5X!

Liquidity/ Funding: We had raised our concerns with the non-deposit taking strategy, but the Group is at no risk at this point as

the balance sheet is fairly liquid and funding has been raised

generally on a longer-term basis. Funding liabilities increased to

R23.9bn, mainly sourced from local asset managers and life

companies. According to management, 93% of the new funding


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Page 4 of 7

Fig 2: Bad debts/ Advances ratio moderated; NPL coverage w orsened but still acceptable

7.9%

8.5%

8.9%

10.1%

10.4%

9.9%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

2005 2006 2007 2008 2009 2010

Baddebt/Advances

65%

63%

69%

66%

63%

55%

57%

59%

61%

63%

65%

67%

69%

71%

2006 2007 2008 2009 2010

NPLcoverage

Source: Company reports, Legae Calculations

Fig 3: ROE has been supported by rising leverage. How much leverage ABI L can sustain is themillion dollar question in our view

0%

2%

4%

6%

8%

10%

12%

14%

16%

0%

10%

20%

30%

40%

50%

60%

2005 2006 2007 2008 2009 2010

ROE

ROA,RHS3.4

3.7

4.7

6.7 6.8

7.8

0

1

2

3

4

5

6

7

8

9

2005 2006 2007 2008 2009 2010

Leverage



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Page 5 of 7

Fig 4: Ellerines rising from the ashes, but we think it is priced in already

59.50%

40.50%

Creditsales

Other

25%

20%

15%

10%

5%

0%

5%

42%

42%

43%

43%

44%

44%

45%

2008 2009 2010

Grossprofit,

LHS

Operatingprofitmargin


Valuation and conclusion: We maintain our sustainable ROE at27.5% for African bank. The CoE reduces to 15.7% on account of

the reduced risk free rate (10-year bond yield declined to 7.8%

from 8.7% on initiation). We obtain a fair/justified PBVR of 4X,

which provides a FY11 value of R20.1bn for African bank.

For Ellerines, the justified PER increases to 10X, on account ofreduced CoE. We value Ellerines for FY11 at R6.12bn, being aproduct of our justified PER and our FY11 earnings estimates of

R615mn (+42%).

FY11 PT shows no upside: We highlight that our PT is now basedon our FY11 estimates. The Group value adds up to R26.3bn,

giving a per share value of R32.7. This is not withstanding our

optimistic view on Ellerines (earnings +42%), as well as African

bank (earnings +29%). The potential total return is -5.2%.

Remember the CoE is compressed by the lower 10-year

Government bond yield. In our view, the upside potential is

difficult to identify and we reiterate our SELL recommendation.


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Legae Securities (P ty) Ltd

Member of the JSE Securities Exchange

1st Floor, Building B, Riviera Road Office Park, 6-10 Riviera

Road, Houghton, Johannesburg, South Africa

P.O Box 10564, Johannesburg, 2000, South Africa

Tel +27 11 551 3601, Fax +27 11 551 3635

Web: www.legae.co.za, email: [email protected]

Analyst Certification and Disclaimer

I/we the author (s) hereby certify that the views as expressed in this

document are an accurate of my/our personal views on the stock or sector

as covered and reported on by myself/each of us herein. I/we furthermore

certify that no part of my/our compensation was, is or will be related,

directly or indirectly, to the specific recommendations or views as expressed

in this document

This report has been issued by Legae Securities (Pty) Limited. It may not bereproduced or further distributed or published, in whole or in part, for any

purposes. Legae Securities (Pty) Ltd has based this document on information

obtained from sources it believes to be reliable but which it has not

independently verified; Legae Securities (Pty) Limited makes no guarantee,

representation or warranty and accepts no responsibility or liability as to its

accuracy or completeness. Expressions of opinion herein are those of the

author only and are subject to change without notice. This document is not

and should not be construed as an offer or the solicitation of an offer to

purchase or subscribe or sell any investment.

Important Disclosure

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objectivity of the analyst(s) with respect to the stock under analysis in thisreport. The analyst(s) do not own any shares in the company under analysis.

Disclosure & Disclaimer

abil_reiterate our sell_improving but lags our expectations

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