08 October 2018 : Following engagement with management and their updated views on the bank, analysts have made some adjustment to their expectation on Fidelity with net-impact lowering their FVE to N2.82 (previously N3.08). Irrespective of the downward review to valuation, analysts still like Fidelity, and remains their preferred pick in the Tier 2 space (after Stanbic) on the back of its strong fundamentals and thus, retain their BUY rating on the stock. Fidelity trades at a FY 18E price-to-book of 0.39x, a premium to Diamond (0.14x) and FCMB (0.18x), which analysts think is justified based on its first-rate ROAE (10.7%) in FY 18E relative to Diamond (2.1%) and FCMB (6.0%). At current price, analyst's expected dividend of N0.15 over FY 18E translates to a dividend yield of ~8%.

In terms of downward revision, analysts have adjusted their funding cost expectation over FY 19F – FY 21F mirroring a lower CASA ratio over the period and higher cost on the refinanced Eurobond. On the positives, analysts now expect loan book to grow by 6% YoY (previously 3%) following a YTD expansion of 3.5% and look forward to a better asset quality over 2018 with NPL ratio revised lower to 6.1% (previously 6.5%). Furthermore, analysts have lowered their forecast cost of risk by 30bps to 1.0%, which necessitated a moderation in loan loss provision by 28% YoY to N8.2 billion (previously N10.3 billion) in FY 18.

On the income line, following the surprise jump in fee and credit income over H1 18, analysts have adjusted their forecast for Non-Interest- Revenue (NIR) higher to N29.5 billion (previously N26.4 billion) which more than offset the downward adjustment of their Net Interest Margin to N70 billion (previously N77 billion).

Net impact of analyst's adjustment translates to an EPS of N0.76 (previously N0.72) in FY 2018. At the end of FY 18, analysts see ROAE touching double-digit (FY 18E: 10.7%, FY 17A: 9.7%) for the first time since FY 12. That said, following upward review to their cost of funds beyond 2018, analysts lower their earnings forecast over FY 19F and FY 20F by 29% and 19% respectively.

Key take-away from Conference Call

Fee Income. As expected, management attributed the increase in credit related fees over H1 2018 to the expansion in loan book. However, management do not expect this trend to run through the rest of the year.

Capital Adequacy Ratio. The loan related to the single obligor charge in its CAR has a tenor of 4 years. The loan is performing and by FY 2020, it should be below the single obligor limit.

Non-Performing Loan. NPL ratio is expected to moderate below the 5% level by FY 2019.

Impairment Write back. N3.3 billion write back in stage 3 loans was from manufacturing sector.

NIR to boost earnings

Going by the trend in H1 18, analysts expect fee income to grow by 41% YoY to N20.6 billion over 2018 given the sizable gain booked in H1 2018 mainly from credit related fees. Also, given the reclassification of interest income1, analysts anticipate some gains amounting to N3.1 billion. Lastly, analysts see limited FX gains (-50% YoY to N5.5 billion) over the rest of the year as current convergence between the NAFEX and NIFEX presents a constraint to booking additional FX gain over the rest of the year. On balance, NIR should expand 9% YoY to N28.2 billion.

Lower Provisioning on the cards

Analysts have lowered their forecast for cost of risk by 30bps to 1.0% (FY 2017: 1.5%) and expect coverage ratio (excluding regulatory requirement) to print at 90% (FY 17: 53%) which necessitated a moderation in loan loss provision by 28% YoY to N8.2 billion (previously N10.3 billion). In terms of asset quality, analysts expect NPL ratio to moderate to 6.1% (FY 17: 6.4%). Major area of concerns still lie around the Oil & Gas (downstream), Transport, Manufacturing and General Commerce sector which combines accounts for 74.5% of total NPL.

Contraction in Net Interest Income imminent

Although, management guided to a higher interest income over H2 2018 due to the upward reversal in yields on fixed income instruments and sustained loan growth, analysts expect Net Interest Income (NII) to be suppressed due to faster growth in funding cost. According to management, the bank has a longer maturity profile on its investment securities and thus, will not be able to benefit much from the uptick in yields over H2 2018, which necessitated analyst's expectation of lower interest income on investment securities over the period. However, given that the jump in loans to customers over H1 18 (specifically the 8% QoQ growth in Q2 18) did not reflect in interest income over same period, analysts now look forward to a more noticeable impact over H2 18. On balance, analysts expect a growth of 6.0% YoY in interest income (N159.8 billion). On the other hand, higher interest expense on term deposits (+5% YoY to N54.8 billion) and higher borrowing cost (+43.8% YoY to N24.2 billion) should cause an overall increase in interest expense (+13.2% YoY to N89.7 billion). Overall, NII should moderate by 1.9% YoY to N70.1 billion.

Elsewhere, analysts forecast operating expense to expand 2.4% YoY to N67.3 billion with Cost-to-Income (CIR) printing at 67.6% (FY 17: 67.5%). Net impact of their overall adjustment translates to PBT of N24.1 billion over FY 18E. Thus, analysts estimate EPS of N0.76 (+17% YoY). Analysts forecast EPS of N0.82 and N1.00 over FY 19F and FY 20F respectively. In addition, analysts forecast a dividend pay-out ratio of 20% (FY 17: 17%) which translates to DPS of N0.15 and dividend yield of 8% based on current pricing.

On regulatory base, analysts believe the bank is on a solid footing as the capital adequacy ratio expanded 200bps to 17% over H1 18. Management guided that the jump resulted from a drop in credit risk assets coming from increased collateral on risk assets and contingents. For the rest of the year, with the consolidation of earnings, analysts expect CAR to end the year at 17.6%.

Reporting for EasyKobo on Monday , 08 October 2018 in Lagos, Nigeria

Source: Emmanuel Adeleke from ARM Securities Limited

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