Global values Kuwait Finance House at KD2.81 and recommends a HOLD on the stock
Global Investment House – Kuwait – Kuwait Finance House (KFH) KFH posted a net profit (attributable to shareholders) of KD275.3mn, exhibiting a surge of 70%YoY in the bottom-line of the bank. The bank’s profitability growth surpassed that of the sector by a great extent, whereby the sector growth as per our universe was around 30%YoY. The bank’s net commission income grew by an soaring 48%YoY despite a supernormal growth of over 100%YoY in 2006. The contribution of net commission income to total income remained relatively unchanged and stood at 38.1% in 2007 against 37.5% reported in 2006. Top-line growth was driven by a combination of high growth of financing assets and a rise in the bank’s spreads, producing a coupling effect. Financing assets grew 41%YoY to stand at KD4.1bn in 2007 while spreads improved from 4.1% in 2006 to 4.7% in 2007. Growth in financings was facilitated by an augmentation in customer deposits which also exhibited a similar growth nearing 44%YoY and reaching KD5.4bn by the end of 2007.
Figure 01: Receivables trend Figure 02 : Customer deposits trend
Source: Annual reports, Global Research
Based on the current market price of KD2.76/share (as on August 20, 2008), KFH’s shares are trading at a 2008E P/E and a 2008E P/BV multiple of 15.3x and 4.6x respectively. Our estimated value for this banking scrip is worked out to be KD2.81 based on DDM (80%) and adaptation of the Gordon Growth Model (20%). According to our fair value the banking scrip offers an upside of just 1.7% over the closing price of KD2.76 per share. We therefore reiterate our HOLD recommendation on the scrip.
KFH was only trivially affected by the charge on the top-line which was due to an adjustment to the financing portfolio that had their terms modified during the year in accordance with the instructions of the Central Bank of Kuwait, whereby estimates of future cash flows of commission income were revised. The adjustment amounted to a mere KD0.56mn, forming an insignificant 0.1% of the unadjusted commission income. While the contribution percentage of Non-commission income remained relatively unchanged, the said head grew by a remarkable 45%YoY driven by sub-heads across the board. A significant portion of the investment income came from capital gains on part sale of associates by subsidiaries. The bank’s subsidiaries disposed off a stake in 3 major holdings during the year, fetching capital gains of KD58.3mn over a carrying value of KD61.8mn. The bank therefore realized a collective 94% return on these investments.
During 2007, KFH also added 6 new major companies to its list of associates, amounting to KD108mn and including United Capital Bank, Kuwait Energy Company and Sukuk Holding Company. The bank acquired stakes amounting to 40%, 42% and 27% respectively, in the mentioned companies. KFH also had a good year from its property investments portfolio, trading in which resulted in gains amounting to KD43.3mn, a rise of 69%YoY. Yields on property investments (realized gains over total property investments at end of year) improved from 13% in 2006 to 18% in 2007. In lieu of its investment strategy, KFH directly and indirectly through its subsidiaries increased its investments in properties by 29%YoY, which stood at KD247mn at the end of 2007.
KFH’s operating efficiency, though still on the higher side as compared to its peers, has improved from the previous year. Cost-to-income ratio decreased from 43.9% in 2006 to 36.6% in 2007 while operating cost to average assets ratio declined from 3.2% to 2.9% over the same period. KFH’s cost ratios remain on the higher side given high cost arising from Murabaha and Ijarah transactions from high depreciation emanating from its subsidiaries.
The Capital Adequacy Ratio of the bank improved significantly from 19% in 2006 to 23% in 2007 due to many reasons including promising profitability growth leading to higher reserves and a capital injection in the form of rights shares. These right shares, with a face value of KD0.1/share were issued at a premium of KD0.9 and hence lead to another boost in Tier-I capital resulting from enhanced share premium reserve. Albeit, the high CAR (only 12% required by CBK) makes the bank more resilient to major delinquencies, the reduction in riskiness comes at a cost paid by its shareholders in the form of capital that remains unutilized due to superfluous capital adequacy maintenance. The asset quality of KFH has improved over the previous year, gauged by a NPL/Gross Loans ratio of 2.6% against 4.1% in 2006. Asset quality has exhibited an improving trend over the past 5 years and seems to be an outcome of good risk management practices. Even though provisions declined due to a KD30mn write-off during the year, a higher absolute decrease in NPLs led to a marginal increase in the coverage ratio which was reported at 139% for 2007.
KFH posted a bottom-line rise of 35%YoY for the 1H2008, with the net profit attributable to shareholders reported at KD116.6mn (EPS: 76fils). Bottom-line was driven by both, net commission income and non-commission income, with the contribution of the top-line increasing from 35% in 1H2007 to 37% in 1H2008. Promising top-line growth of 37%YoY emanated from a 22%YTD surge in financing assets. Furthermore, the interest expense to income ratio declined from 61% in 1H2007 to 59% in 1H2008. KFH became the biggest bank by deposit size during the period under review, with its deposits exceeding KD6.3bn, surpassing that of NBK by KD1bn. Deposits grew at 17.5%YTD during the 1H2008. KFH’s commission income was once again reduced though insignificantly by a charge of around KD35,000 during the period under review. The charge was due to an adjustment from revised estimates of future cash flows of performing financing facilities that had their terms modified during the period. KFH’s non-commission income also witnessed a healthy growth of 15%YoY driven by a surge in most non-commission income sub-heads, except investment income which remained relatively unchanged. Moreover, the bank provided lower provisions during the 1H2008 as compared to the same period last year which seems to be an outcome of improving asset quality. KFH’s income expense ratio increased significantly for 1H2008, standing at 40% from 29% in 1H2007. This was a direct outcome of increasing wages and administrative expectations, due to which operating expense rose 28%YoY.
KFH’s commission income is expected to grow at 23%YoY in 2008 and to maintain a 4-year CAGR of 22%. The net commission income (top-line) is expected to grow a lower 14%YoY in 2008 and the growth rate is expected to pick up in the later years, to exhibit a 2007-2011 CAGR of 19%. Deposits and receivables, driven by favourable macro-economic conditions, rising wages and disposable incomes and the government’s plans to develop mega infrastructure plans in the likes of US$250bn, are expected to grow at a 2008-2011 CAGR of 25%. Contribution of the top-line to total income is anticipated to remain lower than that of non-commission income as per previous trend and the contribution is expected to be range bound between 32% and 37% over the next 4 years as per our assumptions. KFH’s continued investments in properties and in associates and subsidiaries will sustain a healthy growth in investment income which is forecast to rise at a 2008 – 2011 CAGR of 15%. Revenues are also expected to come pouring in from the geographical expansion that the bank is undergoing in the middle-east and in the Far-east region. KFH’s bottom-line is therefore expected to augment by 35%YoY in 2008 and at a 2008 -2011 CAGR of 25%. Growth risks may emanate from increased competition in the Islamic finance market locally with the emergence of newer players like Boubyan Bank. BKME which has also opted for convergence to Islam will also vie for an increased market share once in the playing field of this banking niche and so will KIB.
