Kuwait Finance House (KFH) posted a net profit of $1.3 billion, exhibiting a surge of 70 per cent year on year 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 per cent year on year. The bank’s net commission income grew by 48 per cent year on year despite a supernormal growth of over 100 per cent year on year in 2006.
The contribution of net commission income to total income remained relatively unchanged and stood at 38.1 per cent in 2007 against 37.5 per cent 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 per cent year on year to stand at $15.3 billion in 2007 while spreads improved from 4.1 per cent in 2006 to 4.7 per cent in 2007. Growth in financings was facilitated by an augmentation in customer deposits which also exhibited a similar growth nearing 44 per cent year on year and reaching $20.2 billion by the end of 2007.
Based on the current market price of KD2.76/share as on 20m August 20, KFH’s shares are trading at a 2008 estimated price earnings and a 2008 estimated price to book value multiple of 15.3x and 4.6x respectively. Our estimated value for this banking scrip is worked out to be KD2.81 based on a dividend discount model (DDM) of 80 per cent and adaptation of the Gordon Growth Model of 20 per cent. According to our fair value the banking scrip offers an upside of just 1.7 per cent 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 $2 million, forming an insignificant 0.1 per cent of the unadjusted commission income.
While the contribution percentage of non-commission income remained relatively unchanged, the said head grew by a remarkable 45 per cent year on year 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 of a stake in three major holdings during the year, fetching capital gains of $218.1 million over a carrying value of $231.2 million. The bank realised a collective 94 per cent return on these investments.
During 2007, KFH also added six new major companies to its list of associates, amounting to $404.1 million and including United Capital Bank, Kuwait Energy Company and Sukuk Holding Company. The bank acquired stakes amounting to 40 per cent, 42 per cent and 27 per cent respectively, in the mentioned companies. KFH also had a good year from its property investments portfolio, trading in which resulted in gains amounting to $162 million, a rise of 69 per cent year on year. Yields on property investments, realised gains over total property investments at the end of the year, improved from 13 per cent in 2006 to 18 per cent in 2007. In lieu of its investment strategy, KFH directly and indirectly through its subsidiaries increased its investments in properties by 29 per cent year on year, which stood at $924.2 million 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 per cent in 2006 to 36.6 per cent in 2007 while operating cost to average assets ratio declined from 3.2 per cent to 2.9 per cent 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 (CAR) improved significantly from 19 per cent in 2006 to 23 per cent 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 led to another boost in tier one capital resulting from an enhanced share premium reserve. Although, the high CAR, only 12 per cent is required by the Central Bank of Kuwait (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 unutilised due to superfluous capital adequacy maintenance.
The asset quality of KFH has improved over the previous year, gauged by a non performing loans(NPL)/gross loans ratio of 2.6 per cent against 4.1 per cent in 2006. Asset quality has exhibited an improving trend over the past five years and seems to be as a result of good risk management practices. Even though provisions declined due to a $112.3 million 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 per cent for 2007.
KFH posted a bottom-line rise of 35 per cent year on year for the first half of 2008, with the net profit attributable to shareholders reported at $436.4 million with an earnings per share (EPS) of 76fils. Bottom-line was driven by both, net commission income and non-commission income, with the contribution of the top-line increasing from 35 per cent in the first half of 2007 to 37 per cent in the first half of 2008.
Promising top-line growth of 37 per cent year on year emanated from a 22 per cent year to date surge in financing assets. Furthermore, the interest expense to income ratio declined from 61 per cent in the first half of 2007 to 59 per cent in the first half of 2008. KFH became the biggest bank by deposit size during the period under review, with its deposits exceeding $23.5 billion, surpassing that of NBK by $3.7 billion.
Deposits grew at 17.5 per cent for the year to date (YTD) during the first half of 2008. 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 per cent year on year 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 first half of 2008 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 the first half of 2008, standing at 40 per cent from 29 per cent in the first half of 2007. This was a direct outcome of increasing wages and administrative expectations, due to which operating expense rose 28 per cent year on year.
KFH’s commission income is expected to grow at 23 per cent year on year in 2008 and to maintain a four-year compound annual growth rate (CAGR) of 22 per cent. The top line net commission income is expected to grow a lower 14 per cent year on year in 2008 and the growth rate is expected to pick up in the later years, to exhibit a 2007 to 2011 CAGR of 19 per cent. 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 $250 billion, are expected to grow at a 2008 to 2011 CAGR of 25 per cent.
Contribution of 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 per cent and 37 per cent over the next four 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 to 2011 CAGR of 15 per cent. 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 per cent year on year in 2008 and at a 2008 -2011 CAGR of 25 per cent.
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.