Global value KFH stock at 2,304fils and upgrade its earlier recommendation to BUY

Global Investment House – Investment Update on Kuwait Finance House stock– Kuwait Finance House (KFH) showed excellent results in 2005 exceeding our expectation made in our last report (May-05). The bank reported net profit of KD118.7mn, up 19% as compared to our forecasted net profit for 2005 and 59.5% as compared to the previous year. The banks assets in 2005 too increased by more than 13.5% compared to our estimates.

We have revised upwards our earlier projections due to the excellent performance displayed by KFH during FY2005 and in 1Q-2006. The estimated fair value of KFH’s stock works out to 2,304fils based on DDM. This represents a premium of 12.9% as compared to the current market price. We, therefore, upgrade our earlier recommendation of “Hold” to “Buy” on KFH stock with a medium term perspective.

Financial Performance

The Murabaha, Istisna and Leasing income of the bank increased by 42.3% during 2005 to reach KD189.9mn as compared to KD133.46mn over the previous year. In line with the hardening of yields, the distribution to depositors also witnessed a faster increase of 71.5% to reach KD122.6mn during the same period. Although the bank’s spread reported a decline from 3% in FY2004 to 2.6% in FY2005, we expect it to improve on the back of slight hardening of the yield rates, which should work well for the bank in term of rising spreads.

The net profit attributable to shareholders was higher by 59.5% at KD118.7mn over the last fiscal. The improved net income resulted in EPS moving up from 95.2fils in 2004 to 108.5fils in 2005. The bank’s ROE improved to 25.6% in 2005 as compared to 24.4% reported in the previous year. However, it is to be noted that KFH increased it paid-up capital to KD109.4mn by offering rights and bonus shares leading to equity dilution of 40% in 2005.

Fees and commissions income were up by a whopping 139.5% as the bank increased it fee-based activities such as funds management, investment banking and stock trading in the booming Kuwaiti market. The bank reported investment income of KD140.5mn during the period, a significant 190.8% increase from the previous year. KFH’s gain from sale of investment added considerably to its bottom line as it jumped to KD55.4mn in 2005 compared to only KD12.4mn reported in the previous year.

Equity multiplier of KFH remains more than adequate with Equity to Total Assets Ratio increasing to 12.8% in 2005 as compared to 9.4% reported in the previous year. As a result, the bank remains well positioned to participate in the business opportunities stemming from regional as well as international growth. KFH’s total assets stood at KD4.68bn at the end of 2005, representing a strong increase of 35.4% over the previous year. The return on total assets jumped to 2.9% in 2005 as compared to 2.3% reported in the previous year.

KFH reported net profit of KD37.14mn in 1Q-2006, reporting a strong growth of 51.6% as compared to KD24.5mn reported in the corresponding quarter of the previous year.The total assets of the bank reached KD4.95bn at the end of 1Q-2006 reporting a growth of 5.7% over KD4.68bn reported at the end of 2005. Customers deposits grew to KD3.4bn at the end of 1Q-2006, up 6.5% over KD3.19bn reported at the end of 2005.

Outlook

We believe that KFH will continue to increase its market presence in the Middle East markets especially where it has a strong foothold and increased market share. KFH has been looking favorably at regional alliances as evident by the reports that Sharjah Islamic Bank and KFH are negotiating to launch joint banking services, expand investment cooperation and build a high level of strategic relationships in different Islamic banking sectors. This will help the bank to cross-sell its banking products in the market where it does not have a major presence. KFH is working ahead in establishing its presence in another major Islamic banking hub, Malaysia after setting up the first branch in the country in Sep-05.

KFH has been increasing its deposits using its extensive branch network, technological innovations and aggressive marketing strategies. KFH has also been taking advantage of the customer’s changing preference and migration from the conventional banking products towards Islamic banking products. Despite the stiff competition, deposits from customers increased by 24.4% to reach KD3.19bn at the end of 2005, which was mainly due to the increased liquidity, and hardening of yield rates. KFH’s strength is its low-cost, stable and fast growing deposits which puts it on an advantageous position vis-à-vis other banks in Kuwait.

Kuwait banking sector saw strong growth as the aggregate net profit of the Kuwait banks rose 42.8% in 2005 to reach KD629.8mn. However, the industry leaders, NBK & KFH accounted for 51.5% of the total earnings of the banking sector.

The Islamic banking sector will see increased competition in Kuwait with the establishment of new banks and increased pressure on the conventional banks to offer Islamic products through their separate divisions. This will require banks to adhere to the latest technological innovation in the banking sector, besides vigorously pursuing development of new products. We believe that KFH is well placed to exploit the increase in the Islamic banking activity in Kuwait and the other GCC markets due to its leadership position, strong deposit franchise, extensive coverage, management expertise and strategy of using latest technology and improving customer relationship.

Investment Indicators

Historical P/E & P/BV multiples pertain to respective year-end prices, while those for future years are based on market

price in the Kuwait Stock Exchange as on April 25, 2006.

Source: KFH and "Global’s" Estimates

It appears to us that the 2,040fils at which the KFH is currently trading represents an upside potential of 12.9% at a fair value of 2,304fils arrived as above. The operating environment will prove to be beneficial for KFH where a rising yield environment will help the bank the most because of its significant low-cost Islamic deposit base we expect the bank to post healthy growth in its profits as it expands its operations and increase its market share. Hence, we upgrade our earlier recommendation of “Hold” to “Buy” on the KFH stock with a medium term perspective.