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3.2.2) the valuation of ATW using Two-stage Dividend Discount Model

3.2.2.1) Presentation of ATW

Created in 2004 through the merger of two long-established Moroccan banks, BANQUE COMMERCIALE DU MAROC (founded in 1911) and WAFABANK (founded in 1904), ATTIJARIWAFA BANK is the largest bank in Morocco and the 7th in Africa by total assets.

The Company is engaged in the provision of banking and insurance products and services. The Company's banking activities include personal and professional banking, corporate banking, investment banking, and international banking.

AWB is a major pan-African player: the Group has accelerated its growth in Africa over the last years58:

2005: acquisitions of BANQUE DU SUD (ATTIJARI BANKTUNISIE)September: Banking license granted to open a subsidiaryin SenegalNovember: Acquisition of a 54% stake in BANQUE DUSUD in Tunisia by a consortium of AWB and GRUPOSANTANDERCreation of ATTIJARIWAFA BANK EUROPE2006: Start of AWB operations in Senegal2007: Acquisition of a 67% stake in BANQUE SENEGALO-TUNISIENNE (BST) followed by a merger with AWBSenegal2008:- April: Acquisition of a 79% stake in CBAO in Senegal byAWB, ONA, and SNI and the start of presence in GuineaBissau following the acquisition of CBAO- November: Acquisition of a 51% stake in BIM (Mali)- December: The Merger of ATTIJARI BANK SÉNÉGALand CBAO2009: 5 Acquisition of the CREDIT AGRICOLE retailbanking network in Africa: CRÉDIT DU SÉNÉGAL, la

58 https://www.attijariwafabank.com/fr

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SOCIETE CAMEEROUNAISE DE BANQUES, CREDIT DU CONGO, SOCIETE IVORIENNE DE BANQUE et l’UNION GABONAISE DE BANQUES. Representative office opening in Libya on February

2010: Acquisition by a consortium formed by AWB (67%) and GROUPE BANQUE POPULAIRE (33%) of an 80% stake in BNP PARIBAS MAURITANIE and the launch of banking activities in Burkina Faso via its Senegalese subsidiary CBAO

2011: Acquisition of a 51% stake in SCB Cameroon 2013: Acquisition of a 55% stake in BIA-Togo on

September and the launch of banking activities in Niger on November through CBAO

2015: Increasing stake in the share capital of SIB (75%) and CBAO (83%) and the launch of banking activities in Benin

2017: ATTIJARIWAFA BANK completed the largest acquisition in the bank’s history—the purchase of BARCLAYS's Egyptian operations.

Globally, AWB operates a network of 4,930 branches and had 20,125 employees as of 31 December 2018, managing more than 8.4 m customers. The Group generated an NBI of MAD 22.4 billion as of 31 December 2018.

AWB is listed on the Casablanca stock exchange with a market capitalization of MAD 90.3 billion of 04/21/2019

3.2.2.2)The Bank Strategy: ENERGIES 2020

According to the economic press, the last years were characterized by a broad mobilization around the execution of the bank's strategic plan: "ENERGIES 2020," which is a customer-oriented strategy and model launched in June 2016.

ATTIJARIWAFA BANK aims to position itself as "the relationship-focused bank" through a proactive model, aiming at meeting specific customer needs and taking advantage of new technologies related to digital and data exploitation "Big Data."

The Moroccan bank also aims to consolidate the strengths of its universal banking model, and its fundamental principles:

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business line and geography diversification, and a demonstrated ability to generate growth, rationalize costs and control risks.

ATTIJARIWAFA BANK announced having achieved significant organizational and technological advances in multi-channel distribution, improvement of e-banking platforms, digitalization of its processes (the opening of accounts, mortgage, consumer credit...) and of "Big Data." These developments help to understand the customer's needs better and provide them with an increasingly personalized value proposition and an optimized experience.

After reviewing the commercial bank development strategy now let us take a look at the bank's ROE and payout ratio from 2014 to 2018:

Table 3.4: ATW’s Return on equity and pay-out ratio from 2014 to 2018

In MAD million 2014 2015 2016 2017 2018

Share capital and related reserves 10,152 10,152 10,152 10,152 12,552

Consolidated reserves 24,260 24,907 30,862 33,247 29,388

Group share 20,163 21,421 25,060 27,337 25,596

Minority interests 4,095 3,485 5,802 5,910 3,791 Unrealized deferred capital gains or losses, Group share

851 871 745 819 665

Net income for the financial year 5,140 5,300 5,653 6,584 6,735

Group share 4,355 4,502 4,757 5,391 5,706

Minority interests 785 798 896 1,193 1,029 Equity capital, Group share 31,166 32,444 35,956 38,308 38,813

Return on Equity 15.0% 14.4% 14.7% 15.0% 14.9% EPS 21.40 22.12 23.37 26.49 27.19

Payout Ratio 46.73% 46.69% 51.34% 47.19% 47.81% Dividends 10.00 10.33 12.00 12.50 13.00

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While ROE has been stable around 14.8% over the last five years, net income and dividends have been increasing since 2014, presenting a CAGR of 6.00% and 5.14% respectively:

CAGREPS= 27.1921.40

15 - 1 = 6.00%

CAGRDividends= 13.0010.00

15 - 1 = 5.14%

Note that to calculate ROE in 2018, we have used the net income, Group share in 2018 divided by book equity in 201759. From a conceptual point of view, the profitability should be calculated as the profit of year N on capital invested at the beginning of year N (or at the end of year N-1, which boils down to the same thing) because we must have the availability of capital invested in being able to release a profit in year N.60

To value ATTIJARIWAFA BANK, we will first estimate growth in earnings per share. Second, we will estimate dividends based on expected payout ratios. Third, we will estimate the cost of equity for the first stage and also for the terminal stage. Finally, we will close the valuation by the estimation of the terminal value.

3.2.2.3) Estimating growth in EPS

To estimate the net income growth rate, we will take a look at historical growth, growth from fundamentals61, and see other comparable banks' performances.

59 The method of calculation was supported by a response by Professor Pascal Quiry (Professor at HEC Paris, and co-authored the reference corporate finance textbook "Pierre Vernimmen – Corporate Finance: Theory and Practice), submitted online on March 2017. 60 Using net income and book equity of the year N is probably for reasons for simplicity and allows calculating three years of profitability rather than just 2. 61 Aswath Damodaran uses this approach in his books

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Expected growth rate based on the historical growth rate

Table 3.5: ATW’s historical growth rate: Arithmetic and Geometric Average from 2013 to 2018

Note that the values we have got were calculated this way:

Arithmetic average =(5.17%+3.38%+5.66%+13.33%+ 5.84%)

5 = 6.68%

Geometric average = 5,7064,141

15 – 1

= 6.62%

The difference between the arithmetic average and the geometric average growth rate is insignificant, with a standard deviation in year-to-year changes of 3.84%. ATTIJARIWAFA BANK’s growth has come from acquisitions in Africa. AWB is a major pan-African player: the Group has accelerated its growth in Africa over the last years with the acquisition. In 2017, ATTIJARIWAFA BANK completed the largest acquisition in the bank’s history—the purchase of Barclays’ Egyptian operations. The Moroccan bank plans to launch new acquisitions at the end of 2019, starting with Rwanda, Kenya, and Ethiopia. Thus, the historical growth rate can be a good indicator of future growth.

Expected growth rate based on existing and normalized fundamentals

In this section, we will look at growth from existing and normalized fundamentals.

Year Net income % change 2013 4,141 2014t 4,355 5.17% 2015 4,502 3.38% 2016 4,757 5.66% 2017 5,391 13.33% 2018 5,706 5.84%

Arithmetic average - 6.68% Geometric average - 6.62% Standard deviation - 3.84%

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ATW’s retention ratio of 47.81% and return on equity of 14.90% (as of December 2018) yields an expected growth rate of 7.12% in net income:

Expected growth rate = ROE * Retention ratio

= 14.90% * 47.81% = 7.12%

On the other hand, the expected growth from normalized fundamentals is 5.95%:

Expected growth rate = Normalized ROE * Normalized Retention ratio

= 12.90% * 46.09% = 5.95%

Note that normalized return on equity is calculated based on the average net income during the 2014-2018 period and the book value of equity for 2018, while the normalized retention ratio is computed based on dividends paid in 2018 and the average net income on the 2014-2018 period :

Normalized ROE = Average Net income 2014-2018/BV of Equity 2018

= 4,942/38,308 = 12.90%

Normalized retention ratio = 1- dividends 2018 / average EPS 2014-2018

= 1 – (13.00/24.11)

= 46.09%

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Table 3.6: Estimation of growth in EPS based upon existing and normalized fundamentals - ATW

Net income 2018 5,706 BV of Equity 2017 38,308

Return on equity 2018 14.90% Dividends 13.00

Retention Ratio 2018 47.81% Expected growth rate 7.12%

Average Net income 2014-2018 4,942 BV of Equity 2018 38,308

Normalized return on equity 12.90% Normalized Retention Ratio 46.09%

Expected growth rate 5.95%

The expected growth rate estimated based on comparable banks

Now, let us see how other banks globally and others from emerging markets deliver growth.

Table 3.7: Fundamental growth rate for global and emerging markets banks during 2019

ROE (global) 10.11% Retention ratio (global) 63.80%

Fundamental growth (global) 6.45% ROE (emerging markets) 12.68%

Retention ratio ( emerging markets) 69.90% Fundamental growth (emerging markets) 8.86%

Source: http://pages.stern.nyu.edu/~adamodar/

The expected growth rate for global banks is 6.45% while the one for emerging markets amounts to 8.86%:

Expected growth rate (global) = Normalized ROE * Normalized Retention ratio

= 10.11% * 63.80% = 6.45%

Expected growth rate (emerging markets) = Normalized ROE * Normalized Retention ratio

= 12.68% * 69.90% = 8.86%

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Thus, to value ATTIJARIWAFA BANK, we will use subjectively over the first stage an average of historical growth rates and fundamental growth rates.

Table 3.8: Estimation of the expected growth rate for ATW:

Growth Normalized fundamental growth rate 5.95%

Fundamental growth (current numbers) 7.12% historical growth (geometric average) 6.62% Historical growth (arithmetic average) 6.68%

Average 6.60%

3.2.2.4) Estimation of cost of equity

In terms of risk, we will use for the first five years, the current cost of capital for ATTIJARIWAFA BANK which we estimate to be 7.73%, using an industry beta of 0.85 based on a sample of 50 comparable banks, in conjunction with morocco 5Y Government bond rate of 2.63% and an equity risk premium of 6.00%.

Table 3.9: The estimation of the cost of equity for ATW: DDM – The Two-stage model

High growth stage Stable growth stage

Risk-free rate 2.63% 2.63% Equity risk premium 6.00% 6.00%

Beta 0.85 0.75 Cost of Equity (Ke) 7.73% 7.13%

Concerning the ERP estimation, we have used the survey-based ERP. The historical equity risk premium should be measured over the most extended long period possible62 to reduce the standard deviation of observations (Since stock returns are volatile) and in order to obtain a relevant average. When it comes to the implied ERP, data about buybacks are not publically available. Thus, we could not get a reasonable estimate of ERP.

Note that, at the stable growth stage, we did not adjust beta toward one. Doing so would yield a cost of equity of 8.63%.

62 The Moroccan stock market was the third oldest in Africa, being established in 1929. However, historical data is limited.

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Consequently, the Moroccan bank would look riskier, which is not logical given that firms in the long term, generally, become less risky. Then, we estimated a beta of 0.75 subjectively.

3.2.2.5) The valuation

To value ATTIJARIWAFA BANK using the two-stage model, we will use an EPS growth rate of 6.60% as it was estimated at the last section and a normalized retention ratio that equals 46.09%.

Normalized retention ratio = 1 - DPS2018

average EPS 2014- 2018

= 1 - 13.0024.11

= 46.09%

We will assume that the Pan-African bank's earnings per share will grow 6.60% during the next five years and converge to 3% at the terminal stage. Further, the required rate of return is 7.73% and will converge to 7.13% at the final stage.

The table below underlines the expected EPS, dividends per share, and their present values over the next five years:

Table 3.10: ATW's expected dividends per share and their present value over the next five years using the DDM – Two-stage model

Growth rate EPS Payout

ratio DPS Cumulative PV

Current 27.19 2019e 6.60% 28.98 46.09% 13.36 7.73% 92.82% 12.40 2020e 6.60% 30.90 46.09% 14.24 7.73% 86.16% 12.27 2021e 6.60% 32.94 46.09% 15.18 7.73% 79.98% 12.14 2022e 6.60% 35.11 46.09% 16.18 7.73% 74.24% 12.01

2023e 6.60% 37.43 46.09% 17.25 7.73% 68.92% 11.89

The terminal value at the end of year five can be calculated based upon the earnings per share in year 5, a stable growth rate of 3%, a terminal return on equity of 9.13%, and a terminal payout ratio of 67.14%.

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Terminal value = EPS* 1+growth rate *(1- retention ratio)Ke-g

= 37.43*(1+3.00%)*(1-32.86%)

(7.13%-3.00%) = 627

The retention ratio at the terminal stage was calculated using fundamental growth formula (Growth rate = ROE * Retention ratio):

Terminal retention ratio = Terminal growth rate / Terminal ROE

= 3.00%/9.13% = 32.86%

Thus,

Terminal Payout ratio = 1 - 32.86% = 67.14%

The return on equity at the terminal stage equals the terminal cost of equity (7.13%) plus 2%. We consider that ATTIJARIWAFA BANK will be able to continue to create value for shareholders in the long term, given its competitive advantages. ATW is the largest bank in Morocco and the third largest in Africa possessing a solid financial base and also being part of the most significant privately-owned investment funds in the pan-African scene, AL MADA (its reference shareholder).

Note also that since the cost of equity did not change during the next five years, using a cost of equity or the cumulative cost of equity will yield the same net present values.

Terminal value (net present value) = Terminal value

(1+ Ke)n

= 627

(1+7.13%)5 = 432

Summing up the present value of DPS over the next five years and the terminal value (present value) yields an intrinsic value of 493 MAD. The stock was trading, as of 04/21/2019, at MAD 430. Based on this valuation, the stock would have been undervalued.

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3.2.3) Limitations

The model’s most significant limitation is the difficulty in defining the length of the first stage. A shorter first stage (longer) will leads to undervaluation (overvaluation) of the stock.

Finally, the model does not account for a gradual decline between the first stage and the terminal stage. It is more realistic to assume that the shift from high growth to stable growth happens gradually over time. For example, assuming a growth rate of 15% during the first stage and a growth rate of 3.00% at the terminal stage may not be a scenario that is closer to reality.

3.3) Three-stage Dividend Discount Model

3.3.1) Presentation

While the second stage model allows for two stages, the three-stage dividend discount model allows for three stages. In general, during the first stage, dividends growth is high, and it stays constant for the entire period. Then, in the second stage, dividends' growth decline linearly to a stable growth rate, and finally, on stage three, they grow at a constant stable rate.

Thus, the value of a stock is the present value of expected dividends over the three stages.

Value of the stock =DPSt

(1+Ke;fs )t +DPSt

(1+Ke;ts )t +

Terminal value (TV)

1 +Ke;tsn

t=n

t=1

Where,

TV= DPSn+1Ke; ts -gts

DPSt= expected dividends per share in year tKe= Cost of equity ( : the first stage, : terminal stage)TV= Terminal value at the end of year ng= dividend growth rate for the first n yearsgts

= dividend growth rate for the terminal stage foreverafter year n