NASI and NSE 20 Continue Downward Trend In July

By / Published August 3, 2015 | 6:54 am

During the month, NASI and NSE 20 continued on a downward trend, falling 9.7% and 10.2%, respectively. The last two weeks of the month saw foreign investors turn into net buyers, an indication that the market is starting to look more attractive to them due to currency weakness and also price declines which have made valuations appealing.

The continued decline was as a result of expected lower than historical earnings growth and much worse earnings for some of the companies that reported, such as TPSE and KQ. Large capitalization stocks continued on their losing streak with Centum declining by 21%, Equity Bank 17%, Britam 15%, Safaricom 12% and KCB 9%.

Since their February peak, NASI and NSE 20 have declined by 16.4% and 19.9% respectively. This is a clear correction territory, but given slower than expected earnings growth and a rising interest rates environment, we maintain our neutral stance on equities.

Kenya Airways released full year results for the year ended 31^st March 2015, recording losses for the third year running, a loss of Kshs 25.7 bn, from the previous year’s loss of Kshs 3.4 bn. KQ’s Project Mawingu, a 10 year transformational strategy, seems to have flopped, pushing the firm deeper into losses with the fleet ownership costs edging up 107% to Kshs 26 bn, from Kshs 12.5 bn the previous year.

The firm’s finance costs were up 95.3% as the firm took on more loans to sustain its short-term commitments, as well as purchase new aircrafts. The firm attributes its losses to i) a drop in international oil prices that resulted in a Kshs 5.8 bn loss in their hedging agreement, ii) the impact from the 11% decline in tourism arrivals, and iii) heavy investment in new aircrafts that failed to generate the expected revenue, as it coincided with travel advisories due to insecurity in Kenya and Ebola outbreak in West Africa. The firm seems to need a significant restructuring of its business, including;

Exit loss making routes and concentrate on high margin routes,
Restructure their capital structure, and
Downsize the expansion strategy.

The major shareholder being the Kenyan government means that they can get some bailing out, but this will need to come with much more stringent measures to management and a clear turn around strategy needs to be thought of. As discussed in our Weekly Report #25, a full privatisation is critical to long-term sustainability of KQ. Continued government ownership comes with a moral hazard where management knows that in case the company runs into trouble, there will be a government rescue. Given the troubles at Uchumi, Mumias and KQ, the government should consider an aggressive privatisation strategy.

Growth in the banking sector’s core business was much slower than we have seen in the recent past. NBK registered earnings growth of 123% supported by both funded and non-funded income. The non-funded income increased by 227%, driven mainly by sale of property. Net Interest Income (NII) grew by 18.8% supported by a 30.6% growth in the loan book and 6.4% increase in deposits; the two resulted in an improvement in the loan to deposit ratio to 74%, from 60% same time last year. Net Interest Margin (NIM) came in at 4.9% while operating expenses grew by 4.1%, resulting into cost to income ratio of 54.3% from 71.2% in June 2014.

We will need the exact amount of one time income related to the sale of properties in order to derive the core earnings growth. However, the NII, NIM, cost to income ratio reduction, and loan to deposit ratio growth indicate that NBK franchise is improving. The overall performance is better than our expectations. In our latest banking sector report, we had projected NBK’s long-term growth rate at 5% over the next 5 years, and we are now re-evaluating that assumption with a bias to increasing it. NBK is another institution that can benefit from full privatisation. Going forward, the bank has a lot of room for potential growth and management seems keen to do that.

KCB registered a 13% growth in its PAT supported by 13.5% growth in the NII and 8.5% growth in the Non Funded Income. NIM’s declined to 3.8% from 4.4% as the interest expense grew by 21.5%. Loan book grew by 31.4% while customer deposit grew by 26.0%, bringing the loan to deposit ratio to 72%, well within the banks long-term average. Total operating cost grew by 10.50% driven mainly by growth in staff cost which grew at 12.1%.

However the cost to income ratio remained low at 48.6%. It is expected that KCB will continue growing their SMEs book and also leverage on the alternative distribution channels to drive earnings growth, as it has been a success this far. KCB’s performance is in line with our expectations of a 15% long-term earnings growth, as discussed in our last banking report.

A number of other companies reported their earnings during the week. TPS registered a loss for the second year in a row. The poor performance can be attributed to the impact of a slow down in tourism due to the travel bans into the country as a result of insecurity in the first half of the year, and the Ebola scare which reduced tourist travel across all African countries.

EABL performed well supported by a lower tax rate for the year, restructuring of the company’s debt to slightly cheaper long-term loans, and growth in the export market despite the currency weakness. ARM registered a loss for the year driven by slower growth in revenue amidst increases in financing costs and forex losses during the first half. With the completion of the plant in Tanzania, the company has room for growth by exploring more markets, which should lead to increased capacity utilization and more revenue diversification.

The high interest rates environment may lead to a slowdown in economic growth, which will negatively impact the performance of listed stocks. High rates may lead to an increase in the non-performing loans for banks and weakening quality of earnings. Despite the fact that the market has come down considerably, almost a 20% drop, and valuations are now not too stretched, earnings growth is weak and seems to match the revised valuations. Consequently, we maintain a neutral stance on equities. However, we will be doing analysis to identify companies that can keep growing earnings at high teens in this environment, and those will be the companies to invest in.