Executive Summary

Fixed Income: T-bills were oversubscribed for the 10^th week running, with overall subscription coming in at 149.5%, compared to 122.5% recorded the previous week. Key to note, for the 5^th week running, the 182-day T-bill was not on offer, as the government aims to spread maturity concentration risk evenly across the three papers. Meanwhile, Kenya?s National Treasury has closed the first tranche of its ?M-Akiba?? issue, worth Kshs 150.0 mn, having met its target well ahead of the intended closure date on 10^th April;

Equities: During the week, the equities market registered mixed performance with both NASI and NSE 25 gaining 1.9%, while NSE 20 lost a marginal 0.2%. Communications Authority of Kenya (CA) released the Telecommunications Sector data for Q4?2016, with the sector recording a 3.2% growth in mobile subscriptions to 38.9 mn from 37.7 mn in Q4?2015;

Private Equity: Health and FMCG sectors continue to witness increased investment, evidenced by increased deal flow by global investors including the Distell Group and Healthcare Global Enterprises Ltd, which acquired stakes in Kenya Wines Agencies Limited (KWAL) and Cancer Care Kenya (CCK), respectively;

Real Estate: Government continues to create new initiatives aimed at improving the real estate investment climate in the country, and this week announced (i) waiver of fees on land searches, and (ii) establishment of the Nairobi Metropolitan Transport Authority, tasked with developing a relevant transport system capable of supporting and boosting development in the Nairobi Metropolitan Area. This week we focus on off plan investments in real estate following increased cases of fraud when purchasing off plan;

Focus of the Week: Following the release of the FY?2016 results by listed banks, we analyze the results of the listed banks in the past year so as to determine which banks are the most attractive and stable for investment from a franchise value and from a future growth (intrinsic value) perspective;

Company Updates

• Cytonn?s leading real estate development financing partner, Taaleri of Finland, has successfully completed the first phase of its Africa Real Estate Fund II, exceeding the set targets and surpassing the capital raised in Fund I. Commenting on the raise, our Chief Investment Officer, Elizabeth Nkukuu, CFA, said that ?This is a strong indicator that global institutional investors continue to see strong investment return prospects in real estate in the region.? Taaleri has been the financing partner in our Amara Ridge, Situ Village and The Alma developments.
• We continually showcase real estate developments by our real estate development affiliate, Cytonn Real Estate, through weekly site visits. The site visits target both investors looking to invest in real estate directly, and also those interested in high yield investment products to familiarize themselves with how we support the high yield returns. If interested in attending the site visits, kindly register here
• We continue to see very strong interest in our Private Wealth Management training, which is at no cost, and is held bi-weekly, but is open only to pre-screened participants. To register for the training kindly use this link
• For recent news about the company, see our news section here
• We have 12 investment-ready projects, offering attractive development and buyer targeted returns of around 25.0% p.a. See further details here: Summary of investment-ready projects
• To invest in any of our current or upcoming real estate projects, please visit Cytonn Real Estate
  • The Alma, which is over 55.0% sold, has delivered an annualized return of 55.0% p.a. for investors who bought off-plan. See The Alma.
  • Amara Ridge is currently 100.0% sold and has delivered 33.0% p.a. returns to investors. See Amara Ridge
  • The Ridge Phase One is currently 20.0% sold. See The Ridge
  • Taraji Heights is currently 10.0% sold. See Taraji Heights
• Following the completion of sales for Amara Ridge, we are currently looking for land in Karen for our next development. We are also looking for 3-10 acres of land in Garden Estate, Muthaiga North, South C and Lang?ata. Contact us at res@cytonn.com if you have any land for sale or joint ventures in the above areas
• We continue to beef up the team with the ongoing hires: Careers at Cytonn

Fixed Income

T-bills were oversubscribed for the 10^th week running, with overall subscription coming in at 149.5%, compared to 122.5% recorded the previous week. The 182-day paper was not offered to the auction market for the 5^th week in a row, a move aimed at the management of maturities by spreading the concentration risk evenly across the three papers. Subscription rates for the 91 and 364-day papers came in at 125.1% and 173.9%, compared to 112.2% and 132.8% in the previous week, respectively. Yields on the 91 and 364-day papers remained unchanged, coming in at 8.8% and 10.9%, respectively.

In the recent T-Bill auctions, there has been upward pressure on interest rates as investors continue to demand higher yields, given the high inflation rate, currently at 10.3%. This pressure has been more on the 91-day paper, as it currently offers a negative real return of 1.5%. However, the government has remained disciplined by rejecting bids above market, and we have seen the market respond to this by not bidding too aggressively as indicated by the high acceptance rate for the 91-day paper at 90.8% compared to 70.4% at the start of February. This is an indication that investors are bidding within the ranges that are deemed acceptable by Central Bank.

The volumes transacted in the interbank market increased slightly to Kshs 14.7 bn from Kshs 13.2 bn the previous week, as the average interbank rate declined by 40 bps w/w to 4.1% from 4.5% the previous week.  The money market however remained relatively liquid following a net liquidity injection of Kshs 8.3 bn following a Kshs 12.2 bn injection the previous week. The change in the liquidity position during the week was attributed to a reduction in government payments and T-bill redemptions, which came in at Kshs 36.4 bn and Kshs 11.9 bn (total of Kshs 48.3 bn), from Kshs 39.4 bn and Kshs 23.1 bn (total of Kshs 62.5 bn), respectively, the previous week.

Below is a summary of the money market activity during the week:

According to Bloomberg, the yield on the 5-year Eurobond, which has 2.2 years to maturity, increased by 10 bps w/w to 4.1% from 4.0% the previous week, whereas that on the 10-year Eurobond, which has 7.2 years to maturity, declined by 10 bps w/w to 6.8% from 6.9% the previous week. Since the mid-January 2016 peak, yields on the Kenya Eurobonds have declined by 4.7% points and 2.8% points, respectively, for the 5-year and 10-year bond due to improving macroeconomic conditions. This is an indication that Kenya remains an attractive investment destination.

The Kenya Shilling depreciated by 0.4% against the dollar to close the week at Kshs 103.4 compared to Kshs 103.0 recorded the previous week, on account of increased dollar demand from oil and retail importers. On a year to date basis, the shilling has depreciated against the dollar by 0.9%, while it has depreciated by 0.4% since the Fed rate hike in mid-March. The forex reserve level currently stands at USD 8.0 bn (equivalent to 5.3 months import cover) from USD 7.0 bn (equivalent to 4.6 months import cover) recorded on 17^th March 2017, largely as a result of the receipt of the Kshs 82.3 bn syndicated loan as highlighted in our Cytonn Weekly #12/2017. Going forward, we expect the shilling to come under pressure from (i) global strengthening of the dollar due to planned rate hikes during the year, and (ii) recovery of global oil prices. However, with the current forex reserve level, the CBK will be able to support the shilling in the short term.

Government has re-opened two bonds (FXD 3/2008/10 & FXD 1/2009/10) with effective tenors of 1.4 and 2.0 years, respectively, in a bid to raise Kshs 30.0 bn for budgetary support. Investors will participate until 18^th April, and we shall provide the bidding recommendation for the bonds in our next report.

Kenya?s National Treasury has closed the first tranche of its ?M-Akiba?? issue worth Kshs 150.0 mn, having met its target on 5^th April, 5-days ahead of the intended closure date on 10^th April. This will see the bond issue now proceed to trading on the Nairobi Securities Exchange (NSE) via mobile phone as from 11^th April. 102,632 potential investors registered on the platform of which 5,692 investors subscribed for the issue, with an average investment of Kshs 26,359 per investor. The issue has performed better than we anticipated and it?s yet another milestone for financial technology and mobile money in Kenya. In addition, the government is planning to issue Kenya?s first Islamic Bond (Sukuk) in the 2017/18 fiscal year as an alternative source of financing its development projects. Overall, we believe that these initiatives by the government will have a positive impact in the money market, accelerating the level of financial inclusion in the country.

The Government is ahead of its domestic borrowing for the current fiscal year, having borrowed Kshs 240.4 bn against a target of Kshs 181.0 bn (assuming a pro-rated borrowing throughout the financial year of Kshs 229.6 bn budgeted for the full financial year). The government has only borrowed Kshs 205.8 bn, of the budgeted foreign borrowing, representing 44.5% of its foreign borrowing target of Kshs 462.3 bn, and the Kenya Revenue Authority (KRA) has already missed its first half of 2016/17 fiscal year revenue collection target by 3.2%, and it is expected to miss its overall revenue collection target of Kshs 1.5 tn for the current fiscal year. Given that the government only has 3-months to the close of the current fiscal year and the fact that borrowing from the foreign market is a much longer process than borrowing from the domestic market, the government is likely to use the latter to plug in the deficit that is likely to arise. This creates uncertainty in the interest rate environment as this is a move that may exert upward pressure on interest rates, and result in longer term papers not offering investors the best returns on a risk-adjusted basis. It is due to this that we think it is prudent for investors to be biased towards short-term fixed income instruments.

Equities

During the week, the equities market recorded mixed performance with both NASI and NSE 25 gaining 1.9%, while NSE 20 lost a marginal 0.2%, taking their YTD performances to (0.3%), (2.6%) and 0.2%, respectively. This week?s performance was supported by gains in select bank stocks such as NIC Bank, HF Group, I&M Holdings and Equity Group, which gained 15.1%, 10.8%, 6.9% and 6.1%, respectively. Since the February 2015 peak, the market has lost 43.5% and 25.1% for NSE 20 and NASI, respectively.

Equities turnover increased by 15.3% to close the week at USD 24.1 mn from USD 20.9 mn the previous week. Foreign investors turned net buyers with net inflows of USD 0.7 mn, compared to a net outflow of USD 1.9 mn recorded the previous week, with foreign investor participation decreasing to 65.5%, from 68.7% recorded the previous week. Safaricom and KCB Group were the top movers for the week, jointly accounting for 64.6% of market activity. We expect the Kenyan equities market to be flat in 2017, driven by slower growth in corporate earnings, neutral investor sentiment mainly due to the forthcoming general elections and the aggressive rate hike cycle in the US, which may reduce the level of foreign investors? participation in the local equities market.

The market is currently trading at a price to earnings ratio of 10.8x, versus a historical average of 13.4x, with a dividend yield of 6.4% versus a historical average of 3.7%. The current 10.8x valuation is just 11.3% above the most recent trough valuation of 9.7x experienced in the first week of February of 2017, and 29.5% above the previous trough of 8.3x experienced in December 2011. The charts below indicate the historical P/E and dividend yields of the market.

Kenya?s Cabinet this week approved the State-sponsored Financial Services Authority Bill 2017, which seeks to create the Financial Services Authority, a body that will consolidate and take over the functions of the Capital Markets Authority (CMA), the Insurance Regulatory Authority (IRA), the Retirement Benefits Authority (RBA) and the Saccos Societies Regulatory Authority (SASRA). The merger of the four bodies will (i) provide a consolidated supervisory body for the entire non-banking financial services sector to eliminate regulatory gaps by reducing the number of regulatory bodies, (ii) provide an opportunity for a standard approach to product governance and service delivery, and (iii) raise the level of consumer protection, hence boosting investor confidence in the financial markets.

During the week, the Communications Authority of Kenya (CAK) released the Telecommunications Sector statistics for Q4?2016. Key highlights include:

• Mobile subscriptions increased by 1.2 mn new subscriptions, representing a 3.2% y/y growth to 38.9 mn subscriptions, from 38.5 mn registered in Q4?2015. Subsequently, mobile penetration also grew marginally by 0.5% to 88.2% from 87.7% registered in Q4?2015,
• The minutes of use per subscriber per month in the industry grew by 4.3% to 92.7 minutes from 88.9 minutes registered in a similar quarter last year,
• The total number of Short Messaging Service (SMS) sent during the quarter increased significantly by 95.1% to 15.8 bn messages from 8.1 bn registered in Q4?2015. On a quarterly basis, the number of SMS?s sent grew by 29.5% from 12.2 bn recorded previous quarter, which could be attributed to increased activities during the quarter under review in relations to end of year festivities,
• Internet subscriptions recorded an 11.3% growth to 26.6 mn subscribers from 23.9 mn registered in Q4?2015. Mobile data subscriptions continued to account for the majority of the subscriptions, rising by 3.9% to 26.5 mn subscriptions. Consequently, the number of estimated internet users grew by 11.5% to 39.6 mn users compared to 35.5 mn users registered in Q4?2015. Users grew by 5.0% q/q from 37.7 mn users in Q3?2016 mainly attributed to long school holidays over which the students subscribed to data services. Internet penetration increased to 89.8% from 82.6% in Q4?2015,
• The number of internet broadband subscriptions increased by 76.4% during the quarter under review to 12.7 mn from 7.2 mn recorded in Q4?2015, attributed to the affordability of smartphones in the country as well as affordable internet bundles offered by various internet service operators. The broadband penetration closed at 28.7%, up from 16.8% in Q4?2015,
• Important to note is that ?internet broadband subscriptions? include those subscriptions to homes and offices, while ?internet subscriptions? refer to those offered by mobile operators,
• The number of mobile money subscriptions came in at 31.9 mn subscriptions from 26.7 mn in Q4?2015, while the number of active mobile money transfer agents stood at 161,583 compared to 141,542 agents in Q4?2015. The volume of transactions (deposits and withdrawals) was registered at 456.6 mn with Kshs 1.1 tn transferred during the period. The person-to-person transfers amounted to Kshs 515.9 bn with the rest being used to pay for goods and services,
• Safaricom gained market share across all categories except mobile money. Mpesa market share by the value of transactions declined to 77.6% from 92.8%, while market share by transaction numbers declined to 78.1% from 83.2% registered in Q4?2015. The loss in market share is mainly attributed to Equitel, which has an additional banking channel and hence banking transactions have been included in its market share data whereas Safaricom exclusively focuses on money transfer and payments. Equitel?s market share by the value of transactions grew to 21.9% from 5.6% in Q4?2015. Airtel Money and Orange Money market share by value of transactions were negligible at 0.6% and 0.01%, respectively.

Below is a table summarizing the statistics:

As highlighted in our Cytonn Weekly #3/2017, the telecommunications sector has recorded improved growth in terms of mobile subscriptions and data consumption. Given the rapid population growth and technological advancements, we expect the industry to continue experiencing strong growth.

Nation Media Group (NMG) released FY?2016 results

NMG released FY?2016 results, posting a 24.6% decline in earnings per share to Kshs 8.9 from Kshs 11.8 in FY?2015, attributed to a 5.7% decline in operating revenue compared to a 2.8% decline in operating expenses. Excluding one-off costs totaling to Kshs 342.9 mn attributed to staff reorganization costs and closure costs on QTV, QFM and KFM Rwanda, the group recorded a 9.2% decline in core earnings per share to Kshs 10.7. Key highlights from the earnings include:

• Net sales revenue declined by 5.7% on account of an 8.2% decline in revenue to Kshs 11.3 bn from Kshs 12.3 bn in FY?2015, despite an 18.4% decline in cost of sales to Kshs 2.0 bn from Kshs 2.5 bn in FY?2015. The decline in revenue was attributed to a decline in advertising volumes especially from the government, which accounts for nearly 30.0% of all advertising revenue, and corporate clients due to the challenging business environment in 2016,
• Revenue from all print editions were down, with the exception of Business Daily which had a 1.0% y/y growth. The decline in cost of sales was on account of the efficiency of the new printing press and reworking route to market that led to early arrival of newspapers into the market, which in turn reduced the level of newspapers returned,
• Operating expenses declined by 2.8% to Kshs 6.9 bn from Kshs 7.1 bn in FY?2015. The group incurred a number of one-off expenses in the year totaling to Kshs 342.9 mn including (i) closure costs on QFM, QTV and KFM Rwanda, and (ii) staff reorganization costs,
• Profit before tax declined by 12.9% to Kshs 2.5 bn from 2.8 bn in FY?2015,
• Profit after tax declined by 24.0 % to Kshs 1.7 bn from Kshs 2.2 bn, due to non-recurrence of the Kshs 274.0 mn investment deduction allowance from the new printing press installation made in 2015, which decreased the effective tax rate to 21.3% in FY?2015 against the 31.3% tax rate in FY?2016,
• The Board maintained the dividend per share of Kshs 10.0 for the fifth year running, with a final dividend per share of Kshs 7.5 being declared after the Kshs 2.5 interim dividend per share paid in September 2016. This translates to a payout ratio of 112.4% and a dividend yield of 9.9% at a share price of Kshs 90.0 as at 7^th April 2017.

Going forward, NMG?s growth will be driven by (i) continued leveraging on new press capabilities for efficiency, (ii) strategic partnerships with regional stations such as Star, Lolwe and Njata, and the recent acquisition of Kenya Buzz to expand the audience reach, (iii) strong programming and embedding the digital opportunity through strong social media presence to drive audience and advertising revenue growth on digital platforms, and (iv) regional studios for better brand quality. In addition, key risks for the group will be (i) continued shift from traditional forms of media such as print to digital forms of advertising, hence declining print readership; NMG will have to adapt to this changing medium of information dissemination to remain competitive, (ii) delayed payments from the government, (iii) a recent move by the Kenyan government to centralize its advertising through one government agency via a circular circulated in the Daily Nation, with a similar move expected from the Tanzania government, and (iv) a new regulation in Tanzania, the Media Services Act, which aims to ban foreign ownership of media firms. Therefore, despite this year being an election year, the group still expects weaker advertising revenue mainly due to reduced advertising revenue from the government, which accounts for 30.0% of total advertising revenue.

Below is our Equities Recommendation table. Key to note is that we have updated our valuation on all bank stocks based on their FY?2016 performance and our outlook for the sector in the medium term.

We remain "neutral with a bias to positive" for investors with short to medium-term investments horizon and are "positive" for investors with long-term investments horizon.

Private Equity

Distell Group Limited, a multinational brewing and beverage company based in South Africa, is now the majority owner of Kenya Wine Agencies Ltd (KWAL), after buying out investment firm Centum for an undisclosed amount. The acquisition of Centum?s 26.4% stake brings Distell?s stake in KWAL to 52.4% from a 26.0% stake acquired in 2014 for Kshs 860 mn, translating to Kshs 34.5 per share. KWAL has a total of 96 mn shares, of which 42.7% are owned by state-backed Industrial and Commercial Development Corporation (ICDC), 0.9% by distributors and 4.0% of the shares are set aside for an employee share ownership plan at Kshs 34.5 per share. If offered at the same price, Centum, which acquired a stake in KWAL in 1977 at Kshs 12.2 mn, will be bought out by Distell for at least Kshs 874.3 mn, translating to an annualized holding period return of 11.3%, excluding any income earned from the investment over the 40-year period.

The transaction is seen as a strategic move for Centum, Distell, and KWAL as (i) Centum continues to exit its investments in companies that it does not control, as seen in the sale of its 13.0% stake in UAP Holdings to Old Mutual in 2015, and the sale of its 21.5% stake in insurance brokerage AON in 2016, (ii) KWAL seeks to increase its competitive position in the industry, which will be supported by experience and new capabilities in the ciders, spirits and wine segments that will be provided by Distell, and (iii) Distell seeks to expand geographically through acquisitions and/or partnerships with leading brands in the breweries industry such as KWAL, who in December 2016 were granted a five-year exclusive deal to import and distribute 16 brands made by Distell by Kenya?s antitrust regulator.

Bangalore-based and publicly listed oncology chain Healthcare Global Enterprises Ltd (HCG) plans to acquire a majority stake in Cancer Care Kenya Limited (CCK), a cancer center in Nairobi, upon approval of the deal by the Competition Authority of Kenya. HCG will invest Kshs 93.2 mn (USD 905,000) for 93.8% in CCK, effectively valuing the business at Kshs 99.4 mn. HCG is backed by PremjiInvest, an Indian based family office specializing in private equity and venture capital investments, and the private sector investment arm of the World Bank, International Finance Corporation (IFC), who are its shareholders. HCG has also signed a pact with MP Shah Hospital and Cancer Care Kenya?s promoters to subscribe to shares of CCK after the conclusion of the acquisition. If this pact is concluded, HCG will have a 77.5% stake in Cancer Care Kenya while MP Shah Hospital will have 10%. The target company?s promoters will have the remaining 12.5% stake. The investment into CCK by HCG affirms our view on positive investor sentiment on Africa?s health sector, underpinned by (i) the need to bridge the demand-supply gap existing in the healthcare space, with customers demanding high quality services, especially in specialized treatments like cancer in Kenya, (ii) under provision of quality and efficient health services from the public sector, and (ii) strong economic growth projections compared to global markets, which are supported by positive demographics such as a growing middle class, driving demand for quality healthcare.

Private equity investment activity in Africa has continued to improve, as evidenced by consistent investor interest in the continent. Preference this week has been skewed towards the Healthcare and FMCG sectors. We remain bullish on PE as an asset class in Sub-Saharan Africa given (i) the abundance of global capital looking for investment opportunities in Africa, (ii) attractive valuations in the private sector, and (iii) strong economic growth projections, compared to global markets.

Real Estate

During the week, Knight Frank released the Africa Report 2017, which focused on real estate performance in 2016 in the continent, across all the real estate themes. According to the Kenyan segment of the report, real estate continues to offer attractive returns, but in some segmented themes. The commercial office theme, following increased supply, has witnessed a slight softening in rents and occupancy levels, with the retail sector holding stable despite the addition of 100,000 square meters of retail space in 2016. The residential sector recorded mixed returns with the demand in the low to middle income segment fueling prices and the luxury rents declining by 13.0% from Kshs 485,402 to Kshs 422,300 per month, despite recording price increments. The industrial theme, which has been buoyed by increasing demand for highly specialized facilities, also recorded increased performance with rents, prices and occupancy rising, leading to average rental rates of Kshs 480 per square meter and average rental yields 8.5%. This is in line with our Cytonn Annual Markets Review 2016, which showed improved performance in retail, industrial and residential themes and a slight softening in the commercial office sector.

Source: Cytonn Research

In our Cytonn Weekly #7-2017, where we analyzed the effect the elections will have on the real estate climate, we stated that we expect the government to pass investor friendly policies that will boost or ease real estate transactions and investments. This was witnessed during the week as the Cabinet issued a directive waiving fees for land title searches.  A title search shows details of the land including the registered land owner, acreage and any caveats registered against the title. The process of title search in Kenya has often caused delays on various projects with slow bureaucratic processes that often include bribes, and there have been cases of missing titles or duplicate titles among different individuals. With the costs of the above reduced, we expect more Kenyans will take the initiative of conducting searches on their titles before dealing in property as part of due diligence. The removal of levies is just one of the many reforms that government has been initiating in the Lands Ministry, with the others being:

1. Digitization of the lands records and issuing of title deeds, with the government issuing three million titles in 2016, and,
2. Lowering tax rates for developers who construct in mass and removal of the NEMA and NCA levies.

These legislations are aimed at lowering the costs involved in construction, increasing efficiency and reducing opacity in the Lands Ministry in a bid to increase development and investment in the country. These measures, if successfully implemented, will not only ease transactions processes in the sector and facilitate increased development by enabling land transfers, but also reduce the court tussles that face many Kenyan investors and developers.

The Momentum Africa Real Estate Fund (MAREF), a joint venture between sister companies Momentum Global Investment Management in London and Eris Property Group in South Africa, both of which are subsidiaries of Johannesburg listed MMI Holdings Limited, Africa?s third largest life insurer, announced that it had raised a total of USD 170 mn on its close on 28^th February 2017 from 18 institutions, pension funds and African family funds. The fund seeks to invest in commercial grade real estate in Sub Saharan Africa (SSA), excluding South Africa and seek a net IRR of 18% to the dollar. It currently has 3 projects taking up 23% of the fund, which are two commercial office blocks in Ghana and one office block in Mauritius. This is just one of the many private equity funds that are raising money and investing in SSA. Other funds that have closed or recently invested in Sub Saharan Africa include Actis Fund III, Mara Delta, RMB Westport, Taaleri Africa Real Estate Fund II, and a joint venture between Growth Point and Investec.  This indicates that there is huge investor confidence in the African market and a lot of global capital is seeking to invest in the region and hence developers need to tap into these opportunities.

Another highlight of the week was Cabinets approval for the creation of the Nairobi Metropolitan Area Transport Authority. The Authority will be tasked with (i) developing a relevant transport system capable of supporting and boosting development in the Nairobi Metropolitan Area, (ii) implementation of the integrated transport masterplan, and (iii) managing of the development and implementation of a sustainable Integrated Mass Rapid Transport System. These functions are targeted at reducing congestion and improving connectivity in the Nairobi Metropolitan Area.

Over the last couple of weeks, we have witnessed a number of property buyers coming to the fore claiming to have been swindled by developers over off plan real estate purchases. Specifically, a company called Simple Homes is alleged to have collected approximately Kshs 500 mn from its clients with Kshs 2,000 per person as membership fee and 25% deposits for houses ranging from Kshs 6-7 mn. Another company, Gakuyo Real Estate / Ekeza Sacco is alleged to have collected in excess of Kshs 100 mn from about 7,000 clients in deposits with each paying Kshs 10,000 with the total sum inclusive of subsequent instalments being in excess of Kshs 3 bn. This week we seek to demystify off plan investment in real estate. Off plan investment refers to the purchase of property before completion, generally driven by the high price of real estate and the long time taken to deliver units. The buyer hence buys the property off the plan / design stage of the development. The key advantages of off plan investments are potential capital gains, flexible payment plans and the buyer gets to choose a preferred location and can also choose the finishes to the building. The key risks a buyer faces are (i) loss of capital if the developer goes bust or if they are fraudulent, (ii) the buyer may end up with a lower quality building, (iii) the project may be delayed, or (iv) in rare cases the buyer may get lower returns than expected. When purchasing off plan the buyer should conduct due diligence on the developer as well as the projects you are buying. For the project, the buyer should visit the site regularly to be in the know, confirm the developer has the titles for the given site, confirm the developer has the requisite approvals, know the project team and their delivery history and capability, and research on market performance to gauge expected returns from the development. The buyer should also have an independent lawyer review the contracts to ensure they are not unduly exposed. In the case of Simple Homes, the victims actually put a deposit even before seeing the land or ongoing construction; just insisting on seeing the land and the title would have saved victims falling for the scam. For more on off plan purchasing in real estate see our note on Off Plan Investments in Real Estate

We have a positive outlook for real estate driven by favourable legal policies, improving infrastructure, innovative payment plans and high returns being earned in the sector with increased development activity expected, especially after the elections.

Kenya Listed Banks FY'2016 Report

Following the release of the FY?2016 results by banks, we undertook an analysis on the Kenyan Banking sector to point out any material changes from the Q3?2016 Banking Report. In our FY?2016 Banking Report, we analyze the results of the listed banks in the past year so as to determine which banks are the most attractive and stable for investment from a franchise value and from a future growth opportunity perspective.

The report is themed ?Consolidation and resilience in a challenging operating environment? as the issues facing the banking sector in Kenya persist. Below are some of themes that shaped the banking sector in 2016:

1. Consolidation ? Consolidation in the banking sector continued to gather pace, with weaker banks being forced to merge or be acquired. Also, foreign entities are increasingly seeking to enter the Kenyan banking sector, highlighting the attractive investment opportunity in the financial services sector in the country. Key issues to note here include;
   1. Increased consolidation in the industry, mainly through acquisitions? During the year we witnessed a number of acquisitions in the sector, which include (i) Giro Commercial Bank acquisition by I&M Holdings, (ii) Oriental Commercial Bank acquisition by Bank M, and (iii) Fidelity Commercial Bank acquisition by SBM Holdings, although subject to regulatory approvals in both Kenya and Mauritius. This year, Diamond Trust Bank Kenya (DTBK) has already announced plans to acquire Habib Bank (K) Limited (HBL) setting the platform for more consolidation this year, with the acquisition subject to regulatory approval in both Kenya and Pakistan. As highlighted in our Cytonn Weekly #47/2016 these cases of consolidation in the banking sector will lead to fewer, but larger banks, which are more stable and can withstand shocks in the economy,
   2. Entry of foreign banks into the local banking space ? Kenya?s banking sector has amongst the highest return on equity in the world, with listed banks? ROaE at 19.9%, attracting foreign investors. Going forward, we expect to see more foreign banks targeting the Kenyan banking sector especially following the lifting of the moratorium to license new banks by the Central Bank of Kenya (CBK) early this year, with 2 banks, (i) Dubai Islamic Bank, and (ii) Mayfair Bank, set to be licensed to start operations in the country.
2. Regulation ? There has been a number of regulatory developments that have led to more regulation within the banking sector. These include;
   1. Enactment of the Banking (Amendment) Act 2015? Banks lowered the rates charged on loans to 14.0%, which is 4.0% above the CBR, while interest paying deposits are at a minimum of 70.0% of the CBR. This reduction of banks? yield on assets and increased cost of funding are likely to compress net interest margins, and effectively result in reduced profitability going forward. However, Kenyan banks have been directing funding towards government, which have been yielding higher returns on a risk adjusted basis compared to loans, which are priced at a cap 14.0%,
   2. Adoption of International Financial Reporting Standard (IFRS) 9 - During the year, the Banking Sector ushered in IFRS 9, a new accounting standard that requires banks to increase their loan loss provisioning. The new standard, which is expected to come into full effect in 2018, stipulates that banks should implement a forward-looking approach to estimate credit losses, compared to the current International Accounting Standards (IAS) 39 standards that requires banks to only provide for loans after they have become non-performing. The increased level of provisioning will improve the level of asset quality and resilience in the future hard times, while forcing banks to adopt a more stringent risk assessment framework, which is essential for a stable banking industry.
3. Asset Quality ? The banking sector has witnessed a deterioration in asset quality over the past year, with the gross non-performing loan (NPL) ratio currently at 8.4% from 6.1% in FY?2015. This has led to a more prudent approach by banks based on a stringent risk assessment framework.

Based on the above, we believe consolidation is going to continue in the sector as weaker banks are acquired by the more stable banks, and more foreign entities enter the Kenyan banking sector through such acquisitions, and also through setting up new operations given that the CBK lifted the moratorium to license new banks. The sector is adopting a more prudent banking approach, while key issues such as asset quality and the regulated loans and deposit pricing framework prevail in this operating environment.

Below are some operating metrics for listed banks in Kenya: 

Key takeaways from the table above include:

• The listed banks recorded a 4.4% core EPS growth, compared to a growth of 2.8% in FY?2015. Most banks recorded negative growth with only Standard Chartered Bank and Diamond Trust Bank recording double digit growth at 43.9% and 16.6%, respectively. The other banks that recorded positive growth are I&M Holdings and Co-operative Bank growing at 8.4% and 8.3%, respectively,
• Deposits grew at a faster rate than loans during the year, which is the reverse of what was witnessed in FY?2015. The loan growth was low as the private sector credit uptake recorded a 17-month decline to 4.0%, and also banks adopted more prudent credit risk assessment framework to ensure healthy loan books, consequently the non-performing loans ratio rose to 8.4% from 6.1% in FY?2015,
• Banks were able to protect their net interest margins, even registering an increase to 9.2% from 7.4% in FY?2015. However, the full effects of the Banking Act (Amendment) 2015 that regulates the loan and deposit pricing framework, are yet to be felt and 2017 will provide a much better picture on its impact,
• The increase in non-performing loan (NPL) ratio to 8.4% from 6.1% in FY?2015, highlights increased risks around asset quality in the sector, with banks having taken a prudent approach based on a stringent risk assessment framework, and
• All listed banks recorded a positive return on equity to average 19.9% from 17.1% in FY?2015, supported by the favorable macroeconomic environment that prevailed in 2016 as opposed to 2015, which was characterized by a tough operating economic activity.

Kenya?s listed banks recorded an anemic EPS growth in FY?2016 4.4% from 2.8% in 2015 on the back of structural challenges in the sector, especially on increased provisioning for non-performing loans and the enactment of the Banking Act (Amendment) 2015 that capped interest rates. However, the macroeconomic environment in 2016 remained stable as evidenced by (i) low interest rates for the 91-day T-bill rates, which declined to 7.9%, compared to its 5-year historical average of 9.9%, (ii) a stable inflation rate of 6.3% within the government target of 2.5%-7.5%, (iii) a stable currency, with the Kenyan shilling shedding only 0.1% against the dollar, and (iv) a stable GDP growth coming in at 5.7% as at Q3?2016.  With GDP growth prospects for 2016 at between 5.7% - 6.0%, and the banking sector contributing 10.1% to GDP, the anemic growth exhibited by the sector, highlighted by core EPS growth of 4.4%, is unfavorable for the economic growth of the country. Credit to the private sector has also been on a decline for 17-months, with the International Monetary Fund (IMF) warning that this will probably drag the country?s economic expansion this year. Going forward, we do not expect lending to the private sector to pick up due to the rigidity in loan pricing brought about by the Banking Act (Amendment) 2015, and the crowding-out of the private sector as banks prefer to lend at higher risk adjusted rates to the government.

The sluggish growth currently witnessed in the sector is as a result of structural challenges such as (i) sluggish private sector credit growth, (ii) increasing loan loss provisioning as a result of  concerns around banking sector loan book quality, (iii) asymmetric liquidity distribution in the sector, and (iii) net monetary loss charges by banks that have operations in South Sudan as Equity Group, KCB Group, Co-operative Bank and Stanbic Holding  due to hyperinflation and devaluation of the South Sudanese Pound .

As per our analysis on the banking sector, from a franchise value and from a future growth opportunity perspective, below is the comprehensive ranking of the listed banks.

Major changes include:

• Equity Group dropped by 2 spots to Position 3 from Position 1 in our Q3?2016 Banking Sector Report, being weighed down by an expensive valuation based on Price to Tangible Book Valuation at 1.7x, above industry average of 1.0x, and low deposits per branch at Kshs 1.3 bn, below the industry average of Kshs 3.4 bn indicating a lower level of efficiency in utilizing its extensive branch network to mobilize deposits,
• Standard Chartered Bank rose 3 positions to Position 5 from Position 8 in our Q3?2016 Banking Sector Report as a result of its franchise value, boosted by the bank?s high deposits per branch at Kshs 4.7 bn above the industry average of Kshs 3.4 bn, and a comfortable tangible common equity ratio of 17.0%, which is above the industry average of 14.2%.

For a comprehensive analysis on the ranking and methodology behind it, see our Cytonn FY?2016 Banking Sector Report