SABB’s Core banking income continue to register strong growth

The Saudi British Bank (SABB) – Investment Update- SABB underperformed our earnings estimates for 2006 on the back of lower income from brokerage and mutual fund activities. Reported profits were lower by 5.2% to reach SR2.99bn as against our estimate of SR3.15bn made in our "Saudi Banking Sector – September 2006" report. However, net special commission income were higher by 9.2% to reach SR2.58bn as compared to our estimate of SR2.37bn. Core banking income registered strong growth for the year ended 2006. The meltdown in the capital markets resulted in lower than expected fee income from broking and mutual fund business. Fees from banking services were lower by 20.2% to reach SR1.65bn compared to SR2.07bn.

At the current market price, the stock is trading at 14.2x <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />2007F earnings and 4.0x 2007F book value. Keeping in line with the performance of SABB and our expectations about its future potential, we have valued SABB’s share price at SR97.04. The stock currently trades at SR100.0, which implies that the value arrived at using the weighted average method is 3.0% lower than the current market price. We reiterate our earlier “HOLD” recommendation on SABB's stock.

Financial Performance

Due to the downward trend in the domestic capital markets, deposit growth was particularly strong as funds were moving towards the banking system by way of customer deposits. Customer deposits were higher by 5.3% to reach SR59.3bn as against our estimate of SR56.3bn. On the lending front, loan portfolio of the bank was lower by 9.2% to reach SR42.5bn as compared to our estimate. Overall balance sheet size of the bank was higher by 4.6% to reach SR77.2bn compared to our estimate of SR73.8bn.

The bank's asset quality has been improving during the last three years. Monitoring credit exposures, limiting transactions with specific counterparties and continuously assessing the creditworthiness of counterparties have helped the bank to control credit risk. Gross non-performing loans (NPLs) as a percentage of gross loans have declined from 1.7% in 2003 to 0.4% in 2006. Even in absolute terms, gross NPLs have declined from SR441.7mn in 2003 to SR165.1mn in 2006.

The bank has been aggressively providing during the last three years. Conservative lending policies and aggressive provisioning are a comforting sign to cover incremental delinquencies in case of a systemic shock affecting asset quality in case that happens. Provisions as a percentage of average gross loans increased from 0.29% in 2005 to 0.53% in 2006. Provision coverage ratio of the bank increased from 194.3% in 2005 to 301.4% in 2006.

For the year ended 2006, the bank had 61 branches in the Kingdom. The total number of ATMs increased from 258 in 2005 to 308 in 2006, suggesting enhanced thrust towards providing services through alternative delivery channels like ATMs, mobile banking, internet banking, etc.

Net profit of the bank grew at a CAGR of 33.4% during the last three years. Profits increased from SR1.26bn in 2003 to reach SR2.99bn in 2006. The bank registered a y-o-y growth of 19.3% in profits for the year ended 2006. Profits increased on the back of strong core banking operations coupled with fee from banking services. The bank's return on average assets increased from 2.7% in 2003 to 4.2% in 2006. Also return on average equity increased from 27.9% in 2003 to 38.0% in 2006.

SABB's asset size increased by 16.9% from SR72.8bn in 2Q2006 to reach SR85.1bn in 2Q2007. On a sequential basis, the size increased by 7.0% compared to 1Q2007. Balance sheet size registered 10.3% growth on a year-to-date basis. Customer deposits registered a strong y-o-y growth of 18.4% from SR55.1bn in 2Q2006 to SR65.2bn in 2Q2007. On q-o-q basis (sequential), deposits have increased by 9.0% in 2Q2007. The strong growth registered during 2006 was partly due to the meltdown in the domestic capital market as investor risk aversion increased.

For the first half of the current fiscal, the bank's net income declined from SR1,809.1mn in 1H2006 to SR1,223.2mn in 1H2007, down by 32.4% despite core banking income growing by 18.7%. The decline is attributed to the lower fees from banking services (majority of which is broking and mutual funds related income), which reduced from SR1,217.2mn in 1H2006 to reach SR406.9mn in 1H2007.

The changing demographics is likely to give a further fillip to consumer lending. The bank has been focusing on the credit card business which is gaining traction due to the demographic profile. According to the management, credit card business is a highly lucrative business segment and is likely to be the key focus area of the bank in order to increase its market share as well as increase the penetration level of card business in the Kingdom.

Table 1: 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 Saudi Stock Exchange as on September 18, 2007.

# Book Value is ex-dividend

Source: Global Research, Company Reports