BRAC Bank Valuation PDF

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Sadab Zayeem [email protected]

BRAC Bank Limited

Sector: Banks Initiation Report January 17, 2018

Fair Value Estimate (Dec 2019): BDT 88.6 per share Rating: BUY / Upside: 14.2%

Company Summary 52-week Price Range (BDT) Current Price (BDT) [Jan 10, 2019] Dec 2019 Fair Value (BDT) Price Return Dividend Yield Total Return Number of Shares mn Market Cap USD mn

63.0-108.4 79.8 88.6 11.1% 3.1% 14.2% 1072.5 1009.6

Balance Sheet (BDT Mn) Gross Loans Total Assets Shareholders' Equity Income Statement (BDT Mn) Net Interest Income Operating Profit Net Profit

2017A 202,559 289,501 25,991 2017A 12,148 18,710 5,250

2018E 224,841 312,240 31,385 2018E 13,287 19,073 5,394

2019E 263,064 356,552 34,813 2019E 15,403 22,190 5,565

Growth Gross Loans Total Assets Net interest Income Net profit Per Share (BDT) Adjusted EPS DPS Restated BVPS Asset Quality Gross NPL (%) NPL Coverage (%) Valuation (Consolidated) P/B P/E Miscellaneous NIM Cost to Income ROE ROA CAR Payout Ratio

2017A 16.7% 16.5% 12.4% 17.7% 2017A 4.9 24.2 2017A 3.6% 110.6% 2017A 4.7 22.5 2017A 6.2% 51.6% 22.1% 2.0% 12.7% 0%

2018E 11.0% 7.9% 9.4% 2.7% 2018E 5.0 2.0 29.3 2018E 3.7% 97.0% Trailing 2.6 15.3 2018E 6.0% 54.9% 18.8% 1.8% 14.3% 40%

2019E 17.0% 14.2% 15.9% 3.2% 2019E 5.2 2.4 32.5 2019E 3.6% 87.4% 2019E 2.0 14.5 2019E 6.1% 52.8% 16.8% 1.7% 14.1% 46%

We initiate coverage of BRAC Bank Limited with a December 2019 fair value estimate of BDT 88.6 per share which implies total return of 14.2% (11.1% price return and expected dividend yield of 3.1%). We have used 3-stage Dividend Discount Model (DDM) and Justified P/B multiple to calculate our fair value estimate for BBL with 50.0% weight given to each of the methods used. The stock is currently trading at a P/B and P/E multiple of 15.3x and 2.6x respectively. Our target price implies a forward P/B and P/E multiple of 14.5x and 2.0x respectively. The solo entity grew its earnings by 17.7% during 2017 with an ROE of 22.1%. We expect BRAC Bank to generate an average ROE of 17.9% over the next 5 years with an average loan book growth of 16.0% during the same period.

Key Investment Theses



Superior Governance & Management with Renowned Institutional Sponsor & the Largest Foreign Ownership: BRAC Bank has better corporate governance compared to other private commercial banks in the country which is a direct reflection of its unique shareholding structure. The largest shareholder and sponsoring institution of the bank is BRAC who holds 44.3% stake in the bank and the board structure of bank is also one of the most consolidated with no conflict of interest from directed lending perspective. The bank also has the largest foreign ownership with 40.6% stake in the bank. Moreover, the bank is equipped with a professional and capable management team who enjoy full autonomy with adequate accountability to the board and that operates sustainably in the best interest of the company. The present MD & CEO, Mr. Selim R.F. Hussain, is widely recognized and highly acclaimed across the financial sector of Bangladesh for being the architect of IDLC Finance’s meteoric rise over a period of six years and he has been having similar success with BRAC Bank.



Second Largest SME Portfolio in the Country with a Competitive Advantage: BRAC Bank has the second largest SME portfolio among private commercial banks with ~40% of its loan book concentration in this segment. It also has an extensive distribution network of 457 SME unit offices and 68 SME service centers across the country that gives it an edge in SME banking. SMEs are a big driver of the national economy and BRAC Bank will continue to capture an integral part of this growth with its ‘difficult to replicate’ business model that it has developed from the experience and knowledge of the parent company BRAC. The bank is primarily focused in the ‘S’ of the SME segment (~27% of the total loan book) and it will continue to dominate this segment going forward due to high cost entry barriers. BRAC Bank is also going to gradually roll out appbased agent banking services with up to 500 agent banking outlets by the end of 2019. It will further strengthen its foothold in the SME and retail segment and we expect the SME portfolio of BRAC Bank to grow at an average rate of 18.6% per year.

23

BRAC Bank Limited DSE: BRACBANK



Highest Spread in the Industry: Two factors have helped the bank to achieve industry-highest spread of 7.0% in 2017—37.5% concentration in the SME segment with significant focus in the small segment where BRAC Bank charges ~15-18% for smaller ticket sized loans to cover the provision costs given their uncollateralized status while also recovering the operating costs with a profitable margin. This pushes up the weighted average lending rates of the bank. On the other hand, the bank has a wide distribution network that helps it to mobilize deposits, achieving the industry’s third highest CASA ratio of 49.6% in 2017. This results in a relatively low cost of deposits for the bank. Consequently, the bank had achieved the industry -highest NIM of 6.2% and spread of 7.0% in 2017.



Better Asset Quality and NPL Coverage: BRAC Bank has achieved a relatively clean balance sheet with better asset quality due to stricter NPL recognition practices and high provisioning in the past with no legacy asset quality issues or problems of underreported NPL or provision shortfall at the bank. The new management has also revised the bank’s credit underwriting standards in 2015 and brought changes in management policies and practices to limit new NPL formations. The bank has developed relatively strong credit risk framework and special mention accounts (SMA) as percentage of total loans is also only 0.6%, which is the lowest among our coverage banks. Moreover, BRAC Bank has achieved an NPL coverage of 110.6% in 2017 and this will have a positive impact on the future ROE of the bank— we estimate an average adjusted ROE of 18.2% for the next five years.



Well-poised Bank for Basel III Implementation: It is one of the better capitalized banks in the industry with tier-1 and capital adequacy ratio of 11.2% and 12.7% respectively at the end of 2017. In June 2014, BRAC Bank completed a 1:2 rights offer (1 new share for every two existing shares) following which tier -1 ratio increased from 8.4% in 2013 to 12.0% in 2014 and the bank still continues to enjoy a high tier-1 ratio. Moreover, in 2017, the management decided to pay 25% stock dividend instead of cash in a move to retain capital within the bank during the year. We forecast an average CAR of 13.7% for the bank in the next 5 years and it is expected to comfortably comply with Basel III’s capital requirements. The management also plans to undertake long-term capitalization strategy going forward.



Global MFS giant bKash: BRAC Bank owns 51% equity shares in bKash who controls more than 80% market share in Bangladesh. bKash has more than 30 mn+ users with more than 180,000 agents across the country where users have grown more than 10x while annual transactions have grown more than 20x since 2011. In 2017, net revenue of bKash has grown 17.9% and PAT has also increased by 26.2%. On April 26, 2018, bKash and the operator of Alipay, Ant Financial Services Group announced a strategic partnership in which Ant Financial is going to invest in the technological capabilities of bKash in return for a 20% stake in the company. Alipay has gained vast firsthand experience and knowledge from economies like China which will heavily benefit bKash in the coming years. Currently bKash is providing two of the four MFS services: mobile payments and mobile savings, and we expect microcredit and insurance products to be rolled within the next 5 years. bKash will continue to be the market leader in MFS and we estimate a valuation of USD 829.2 mn on a standalone business for bKash where BRAC bank has ~ 42.0% economic interest in the company.

Risks



Competition in SME Lending May Increase Over Long Term: Few banks are giving increasing attention to other segments such as SME and retail loans with plans to expand their loan portfolio in these areas. If some of the smaller players and new entrants successfully build SME capability over the years, it will spike up competition and diminish profitability in this segment, as has happened in the corporate segment in recent times.



Regulatory Risks for bKash: The regulatory regime will continue to remain volatile for bKash since the MFS industry of Bangladesh is still at a nascent stage of development. Moreover, bKash is regulated by Bangladesh Bank as per Bangladesh Mobile Financial Services (MFS) Regulations, 2018 whereas the recently launched government backed mobile banking service ‘Nogod’ is being governed by Bangladesh Postal Act Amendment 2010. The latter regulation allows ‘Nogod’ to operate outside the existing stricter MFS regulations and to bypass the maximum cash in/ cash out limit set by Bangladesh Bank for the private MFS players. Such differential treatment of firms in a single industry can generate unhealthy competition and is a risk for bKash.

24

BRAC Bank Limited DSE: BRACBANK

Key Investment Theses Superior Governance & Management with Renowned Institutional Sponsor & the Largest Foreign Ownership BRAC Bank has better corporate governance compared to other private commercial banks in the country. The superior governance of BRAC Bank is a direct reflection of its unique shareholding structure, which largely consists of reputed local and foreign institutions rather than a few high net worth individuals which is more common in the banking industry of Bangladesh. For instance the largest shareholder and sponsoring institution of the bank is BRAC, which is the largest NGO in the world with presence in 11 countries, who holds 44.3% stake in the bank whereas local institutions (8.7%) and foreign institutions (40.6%) together hold another 49.1% stake in it leaving only 6.5% for local retail investors. So there is no conflict of interest from directed lending perspective. The board structure of BRAC Bank is also one of the most consolidated in the industry with Sir Fazle Hasan Abed, KCMG as the chairman of the board including four nominated directors of BRAC and three independent directors. The bank is also equipped with a professional and capable management team who enjoy full autonomy with adequate accountability to the board and that operates sustainably in the best interest of the company. The present MD & CEO, Mr. Selim R.F. Hussain, who joined the bank on 8 November 2015 is widely recognized and highly acclaimed across the financial sector of Bangladesh for being the architect of IDLC Finance’s meteoric rise over a period of six years and he has been having similar success with BRAC Bank. For Instance, within a year of his appointment, adjusted ROE of the bank increased from 12.7% in 2015 to 20.2% in 2016. The bank ’s SME portfolio also increased from 35.3% in 2015 to 40.1% in 2017 under his leadership. Unlike other CEOs in the industry, Mr. Selim has a clear laid out strategy for the organization and he will continue to drive the performance of the bank going forward.

Shareholding Structure (2018) Public, 6.5%

Sponsor, 44.3% Foreign, 40.6%

Institutes, 8.7%

25

BRAC Bank Limited DSE: BRACBANK

Second Largest SME Portfolio in the Country with a Competitive Advantage BRAC Bank has the second largest SME portfolio among private commercial banks with ~40% of its loan book concentration in this segment. It also has an extensive distribution network of 457 SME unit offices and 68 SME service centers across the country that gives it an edge in SME banking. Given SMEs are the lifeblood of the country’s economy, constituting around 99% of the business units in the country with 25% contribution to the nation’s GDP and generating 40% of the employments, we believe that SME will continue to be a big driver of the national economy and BRAC Bank will continue to capture an integral part of this growth. We forecast that SME segment of the bank will grow faster than corporate and retail loan portfolio and the bank’s SME concentration will increase to 45.0% by 2022. Most of the bank’s SME advantage stems from its ‘difficult to replicate’ business model that it has developed from the experience and knowledge of the parent company BRAC, the largest non-government organization (NGO) in the world. The bank primarily operates in the ‘small segment’ of the SME loans (27.0% of total loan book), which is collateral free with high provision costs and requires a large number of people to operate. This results in high operating costs of the business that acts as an entry barrier for other banks diverting them towards the collateral based ‘medium sized’ loans. The only close competitors of BRAC Bank in the SME business is the Islami Bank Bangladesh Limited (IBBL) with 3.7 times the portfolio size but it is rather focused on the medium-sized loans, and IDLC Finance Limited with a portfolio size of 0.4 times of BRAC Bank. We believe that other players will not gain much traction in this business anytime soon and BRAC Bank will continue to be a dominant player in the ‘S’ of the SME segment and the SME portfolio is expected to grow at an average rate of 18.6% per year.

SME Portfolio Size (BDT bn) - 2017

SME as % of Total Loans - 2017

350

45%

44.4%

303.4 44%

300

43%

250

42% 200

40.8%

41% 40.1%

150 100

40%

81.6

39%

30.9

50

38%

0

37% BRAC

IDLC

IBBL

BRAC

IDLC

IBBL

Moreover, BRAC Bank has made major technological investments in their core banking system and it is going to gradually roll out app -based 24/7 agent banking services with up to 500 agent banking outlets by the end of 2019 with up to 20 banking products and services. Given its flexible customer -centric approach to banking, we expect BRAC Bank to further strengthen its foothold in the SME and retail segment as it will lower their cost of doing business (i.e., increase profitability) in the niche market through digitalization of its banking services across Bangladesh. This model will also play a major role in driving significant growth of the bank ’s balance sheet over the medium term.

26

BRAC Bank Limited DSE: BRACBANK

Highest Spread in the Industry BRAC Bank had the highest spread of 7.0% in 2017. Two factors have primarily helped the bank to achieve this spread. First, the bank has a loan book mix of 37.5%, 44.5%, and 18.0% in the SME, corporate, and retail segment respectively. Since small SME loans are essentially uncollateralized assets with high provision costs, most banks are not willing to disburse loans to the BRAC Bank’s customer group, allowing BRAC Bank to charge a higher interest rate of ~15-18% to cover the costs of these loans with a profitable margin. This pushes up the weighted average lending rates of the bank. As of 2017, the weighted average lending rate of the bank stood at 10.3%. On the other hand, the bank has a wide distribution network with 186 branches, 457 SME unit offices, and 68 SME service centers that helps it to mobilize deposits. As a result, the bank has achieved the industry ’s third highest CASA ratio of 49.6% in 2017. This results in a relatively low cost of deposits for the bank. As of 2017, the weighted average deposit rates for the bank stood at 3.4%. Consequently, the bank achieved the industry -highest NIM of 6.2% and spread of 7.0% in 2017.

Loan Portfolio Mix (2017)

Distribution Network (2017) 500

457

50%

447

450

44.5%

45%

400

40%

350

35%

300

30%

250

25%

186

200

37.5%

18.0%

20%

150

15%

68

100

10%

50

5%

Branches

SME Unit Offices

SME Service Centers

0%

ATMs

SME

Retail

Deposit Rate

CASA Ratio 8%

56%

Corporate

7.5%

54.6%

7% 54%

52.8%

5.6%

6%

52%

51.0% 49.6%

50%

50.0%

4.8%

5%

4.8%

5.1%

50.0%

4%

3.2%

3.4%

2016

2017

3%

48%

48.3%

48.1%

2%

46%

1% 0%

44% 2013

2014

2015

2016

2017

2018E

2019E

2020E

2013

2014

2015

Lending Rate 18%

4.5%

10.3%

10.3%

6.4%

6.4%

6.4%

2018E

2019E

2020E

8.1%

8%

14% 12%

2020E

8.8%

9%

13.8% 11.4%

2019E

Spread 10%

16.4%

16%

2018E

11.0%

11.3%

11.6%

7.2% 6.5%

7%

7.0%

6%

10%

5%

8%

4%

6%

3%

4%

2%

2%

1% 0%

0% 2013

2014

2015

2016

2017

2018E

2019E

2020E

27

2013

2014

2015

2016

2017

BRAC Bank Limited DSE: BRACBANK

Better Asset Quality and NPL Coverage BRAC Bank has achieved a relatively clean balance sheet with better asset quality due to stricter NPL recognition practices and high provisioning in the past. As a result, there are no legacy asset quality issues or problems of underreported NPL or provision shortfall at the bank. The new management has also revised the bank ’s credit underwriting standards in 2015 and brought changes in management policies and practices to limit new NPL formations. Specifically two major changes were brought in the Credit Risk Management (CRM) framework to strengthen the bank ’s risk management capacity: a) Underwriters have been shifted under the CRM division instead of the usual business units to eliminate any conflict of interest b) Regional CRM teams have been formed in support of the centralized CRM teams. This structure allows the regional teams to seek help from the centralized CRM teams in carrying due diligence, and the centralized team can also get help from the regional teams to carry out and monitor field level inspections. Moreover, none of the bank ’s large corporate borrowers has applied for large loan restructuring in 2017 which shows relatively strong credit risk framework of the bank. Special mention accounts (SMA) as percentage of total loans is also only 0.6%, which is the lowest among our coverage banks. Unlike other banks, BRAC Bank has also been able to clean its asset base with high provisioning over the last few years and has achieved an NPL coverage of 110.6% in 2017. This will have a positive impact on the future ROE of the bank— we estimate an average adjus...