Zenith Bank plc - WSTC Financial Services

Zenith Bank plc

Summary

We initiate coverage of Zenith Bank plc (Zenith Bank) with a HOLD recommendation

based on an estimated fair value of NGN14.63, 12-month cum-div target price of

NGN17.27.

Zenith Bank is the second largest bank in Nigeria by balance sheet size,

with total assets worth NGN1.895 trillion as at December 31, 2010. Between

2006 and 2010, the bank grew its assets at a CAGR of 32%.

Zenith Bank is known for its aggressive growth of network and market

share, while keeping its focus on quality and a conservative approach

towards creating (loan) assets. While seeking to maintain its position as a

leading financial service provider in Nigeria, the bank has proposed a

cautious approach towards global expansion.

Zenith Bank was a net beneficiary of the result of the stress test of Nigerian

banks carried out by the Central Bank of Nigeria in 2009. Going forward, we

expect Zenith Bank to benefit significantly from the strong economic growth

expected in the country over the next few years, which will be driven by

investments in critical infrastructure within a stable polity.

However, Zenith Bank is still exposed to varying risks as a result of global

and local macro-economic concerns, and ongoing reforms in the financial

services sector. Although the potential emergence of foreign banks

(especially from South Africa) could be a threat, the large population of the

unbanked, its strong niche position, in addition to strengthened risk

management puts Zenith Bank in a good position to weather the storm.

Zenith Bank’s relative competiveness stands it in good stead to take

advantage of business opportunities as they arise.

Report Date 28 June 2011

FAIR VALUE 14.63

12-month cum-div target price 17.27

Current price 14.80

Total Expected Returns 16.72%

Recommendation HOLD

52 week price range (NGN) 11.21 – 16.70

Market Cap (NGN’billion) 465

Common Shares

Outstanding (million) 31,396

Fiscal Year End December

Auditors KPMG

Contact: Ayo-Oluwa Aderibigbe

[email protected] +234 (1) 4618490 Oluwatosin Sanusi

[email protected] +234 (1) 4618490 Babajide Fadahunsi

[email protected] +234 (1) 4618490 [email protected] www.wstcfinancialservices.com

IMPORTANT DISCLOSURES ARE INCLUDED AT THE END OF THIS REPORT

INITIATING COVERAGE Nigeria Equity Research

52 week share price movement; rebased to 100

Source: Nigerian Stock Exchange, WSTC Research

Zenith Bank plc

2006 2007 2008 2009 2010 2011e 2012e 2013e 2014e 2015e

Adj. EPS 0.38 0.58 1.64 0.65 1.19 1.60 2.13 2.61 3.10 3.70

Adj. DPS 0.21 0.30 0.91 0.36 0.85 1.00 1.35 1.69 2.04 2.43

Adj. NAPS 2.28 3.46 7.37 10.90 11.17 11.70 12.20 13.06 14.06 15.23

P/E 39.3 25.3 9.0 22.7 12.4 9.3 7.0 5.7 4.8 4.0

P/Bk 6.5 4.3 2.0 1.4 1.3 1.3 1.2 1.1 1.1 1.0

ROA 2% 2% 4% 1% 2% 2% 3% 3% 3% 3%

ROE 17% 17% 22% 6% 11% 14% 18% 20% 22% 24%

Source: Company Reports, WSTC Estimates

*P/E, P/Bk based on current price of NGN14.80

020406080

100120140

NSE ASI Zenith Bank

Zenith Bank plc Equity Research June 2011

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About the Bank

General Information

Zenith Bank plc (Zenith Bank) was incorporated in Nigeria as a private limited

liability company on 30 May, 1990. It was granted a banking license in June 1990

to carry on the business of commercial banking, and commenced business on 16

June 1990. Zenith Bank was converted to a public limited liability company on 20

May 2004, and its shares were listed on the floor of the Nigerian Stock Exchange

on 21 October 2004 following a highly successful Initial Public Offering.

Zenith Bank is headquartered in Lagos, Nigeria. It has over four hundred (400)

branches and business offices nationwide. Zenith Bank has presence in all the

state capitals, the Federal Capital Territory (FCT) and major towns and

metropolitan centres in Nigeria. The Bank's expansion is not limited to Nigeria as

Zenith Bank became the first Nigerian bank in 25 years to be licensed by the

Financial Services Authority (FSA) in the UK for the commencement of banking

operations by Zenith Bank (UK) Limited in April, 2007. This is in addition to its

presence in Ghana, Zenith Bank (Ghana) Limited, Sierra Leone, Zenith Bank

(Sierra Leone) Limited, Gambia, Zenith Bank (Gambia) Limited and a

representative office in Johannesburg, South Africa.

Zenith Bank offers its clients a wide range of corporate, investment, business and

personal banking products and solutions.

Subsidiaries

Company

Percentage

Ownership Services offered

1 Zenith Securities Limited 99.989 Securities trading and asset management services

2 Zenith General Insurance Company Limited 80.1224 General (non-life) insurance services

3 Zenith Registrars Limited 99.9969 Registeration and share transfer agency services

4 Zenith Bank (Ghana) Limited 98.0722 Corporate and retail banking services

5 Zenith Pensions Custodian Limited 99 Pension funds custodial services

6 Zenith Life Assurance Company Limited 81.6132 Group life and individual policy cover

7 Zenith Bank (UK) Limited 100 Commercial, wholesale, investment, retail banking and

financial services

8 Zenith Capital Limited 99.9996 Investment banking services

9 Zenith Bank Sierra Leone Limited 100 Corporate and retail banking services

10 Zenith Bank Gambia Limited 100 Corporate and retail banking services

11 Zenith Medicare Limited Health Insurance and managed care services

12 Zenith Trustees Limited Trust services and non-pension fund custodial services

13 Zenith Realtors Limited The real estate investment company of the Zenith group

Source: Company Reports


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Following the new licensing regime of the Central Bank of Nigeria (CBN) in 2010,

the bank has indicated its intention to apply for a commercial banking license

with international authorisation. As such, the bank has recently obtained

shareholders’ resolution to divest the bank of its non-banking subsidiaries.

Credit Rating

Shareholding Structure

As at 31 December 2010, Zenith Bank had 707,623 shareholders on its register

of members. The table below shows the shareholding structure and shareholders

holding more than five per cent of the issued share capital of the bank:

Strategy

Aggressive growth; driven by focus on quality and conservative business model

Over the years, the Zenith brand has been synonymous with aggressive growth

yet combined with a focus on quality delivery.

Zenith Bank has seriously leveraged the use of Information and Communication

Technology (ICT) in banking and generally increasing the performance standards

in the Nigerian banking industry. The bank's main service delivery channels

remain its business offices (branches and cash offices), which currently stand at

over 400 while also offering electronic banking services and channels, such as

Internet banking, bills payment platforms, and telephone banking services

amongst others.

These business offices are located in prime business and commercial cities in

each state of the federation and they are easily accessible to the 22 CBN

clearing zones all over Nigeria. Within the first decade of commencing

Rating Agency Rating

Fitch Ratings (2010 Internatiional) B+

Standard & Poor's (2010 Internatiional) B+/B

Source: Zenith Bank plc

Shareholder Holdings Percentage Holdings

Jim Ovia 2,747,223,748 8.75%

Stanbic Nominees Nigeria Limited 1,821,098,593 5.80%

Others 26,828,171,445 85.45%

31,396,493,786 100.00%

Source: Company Reports


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operations, the bank made its mark in profitability and all other performance

indices in Nigeria and has maintained this position to date, just behind other

banks that commenced businesses several decades ago.

The following are the key strategies driving Zenith Bank’s vision which is to build

the Zenith brand into a reputable international financial institution recognized for

innovation, superior customer service and performance while creating premium

value for all stakeholders. The strategies are:

Compete aggressively for market reach, but focus on high quality assets

and top-end relationships.

The bank continually strives to remain conservative but innovative.

Focus is on deploying extensive branch network to generate cost-

effective deposits from the retail end of the market to lend to the

corporate end with emphasis on emerging business opportunities.

Encourages strong risk management and corporate governance

practices. Indeed, the bank has consistently recorded one of the lowest

provisions as percentage of loans and total assets among banks in

Nigeria.

Delivering superior service experience to all customers at all times.

The bank executes this strategy by continuous focus and investment in

attracting and keeping the best brains, the use of cutting edge technology

and deploying superior customer service.

Develop deeper and broader relationship with all clients and strive to

understand their individual and industry peculiarities with a view to

developing specific solutions for each segment of their customer base.

Strive to be a leading service provider in Nigeria by continuing to build on

longstanding relationships, capabilities and the strength of their brand and

reputation.

Optimally expand their operations by adding new distribution channels and

entering into new markets where opportunities exist.

The bank has identified growth opportunities along the following lines:

By Sector- significant opportunities exist to meet the funding gaps in

power, infrastructure, telecoms


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By Business- Diversification by business lines and geography

By Distribution- Approximately 70% of Nigerians are unbanked. Continue

with cautious branch expansion of mobilizing cheap deposits to fund high

end corporate customers

By innovation- ICT to reinforce competitive advantage

Strong capitalisation and liquidity, alongside conservative loan-to-deposit

ratios gives adequate headroom for loan growth.

Maintaining Zenith Bank’s position as a leading service provider in Nigeria,

while expanding its operations internationally in West Africa and the

financial capitals of the world.

The bank has proposed a cautious approach towards global expansion.


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Financial Analysis

Balance Sheet

Zenith Bank plc is the second largest bank in Nigeria by balance sheet size, with

total assets worth NGN1.895 trillion as at December 31, 2010. Between 2006

and 2010, the bank grew its assets at a CAGR of 32%. Assets growth was

aggressive between 2006 and 2008, averaging 76%; while assets declined in

2009 as a result of the crisis that hit the Nigerian banking industry. However in

FY2010, assets grew 14% as the bank consolidated its position in the Nigerian

banking industry.

In our analysis, we forecasted Zenith Bank’s assets to grow at a CAGR of 14%

over our forecast horizon 2011e to 2015e. An average growth of 15% is expected

between 2011e and 2013e, while growth is expected to decline to 13% by 2015e.

Our opinion of growth is a base case scenario, considering the potential growth

opportunities that exist if the much needed institutional reforms are successfully

carried out in Nigeria. The Nigerian segment of Zenith Bank accounted for 97.5%

of the group’s assets.

Asset Composition

Until FY2008, Zenith Bank maintained conservative asset allocation, with ‘loans

and advances’ averaging 29% between 2006 and 2008. Loans and advances

increased from 26% of total assets in FY2008 to 42% in FY2009. It is important

to note that, the assets allocated to loans increased largely due to the

reallocation of ‘capital market assets’ to ‘loans and advances’, that is, the bank

Zenith Bank Asset Composition: 2006 to 2010

Source: Company reports, WSTC Estimates

6% 6% 5% 6% 5%

36% 39%26% 24% 27%

33% 30%

26%42% 40%

25% 25%43%

28% 29%

0%

20%

40%

60%

80%

100%

2006 2007 2008 2009 2010

Other assets Capital market assets

Loans & advances Cash & short term assets


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basically reallocated its risk assets. The asset reallocation from ‘capital market

assets’ to other asset classes started in FY2008, when it shed 13% compared to

previous year and ‘cash and short term assets’ increased by 18% over the same

period. This might have been as a result of strong risk management on the part

of the bank, which therefore minimized its downside risk when the Nigerian

banking crisis struck.

As at 31 December 2010, asset compositions in the peer group (First Bank,

GTBank, UBA and Zenith Bank) were closely aligned. Zenith Bank had the

highest ‘cash & short term assets’, while its ‘loans & advances’ was 5% below

the peer average of 45%. Compared to the peer average of 24%, Zenith Bank

had 27% of its assets in ‘capital market assets’ and its ‘other assets’ was in line

with a peer average of 5%.

In our analysis, we projected ‘loans & advances’ to average 43% of assets over

the forecast horizon, 9% higher than the historical average of 34%; growing at an

average of 100 basis points yearly between FY2011-FY2014. Our expectation on

the increase in the component of ‘loans & advances’ in the assets of Zenith

Bank, is premised on the role we expect the bank to play in credit creation, which

is needed to drive the real sector of the economy. On the other hand, ‘capital

market assets’ is expected to remain flat over the forecast horizon, while ‘cash &

short term assets’ and ‘other assets’ are forecasted to average 22% and 5%

respectively.

5% 5% 6% 5%

18% 18%32% 27%

50% 53%39%

40%

27% 23% 23% 29%

0%

20%

40%

60%

80%

100%

First Bank GTBank UBA Zenith Bank

Other assets Capital market assets

Loans & advances Cash & short term assets

Peer Comparison of asset composition: December 2010



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Loans & Advances

Over the previous five financial years, Zenith Bank’s ‘loans & advances’ grew at

a CAGR of 37%, while there was a significant change in the loan mix. A

significant proportion of the bank’s ‘loans & advances’ was in ‘overdrafts’ and

‘others’ type of loans (largely commercial papers), in FY2006. Between FY2006

and FY2010, there was a drastic change in the loan mix, with 60% of Zenith

Bank’s loan portfolio now allocated to ‘term loans’, from a low of 13% in FY2006.

There was a drastic decline in other types of loans, while the proportion of

‘overdraft’ was relatively stable over the period.

The growth in ‘term loans’ may be explained by the availability of deployable

funds due to the injection of equity capital over the historical period, which also

coincided with the global economic boom. Therefore, since equity capital is more

patient that depositors’ fund, Zenith Bank could afford to switch to longer term

maturity loans.

Asset Quality

As at FY2010, Zenith Bank had 96% of its loans secured, while 4% were

unsecured. Loans secured by ‘real estate’ made up 47% of total loans, while

loans that were ‘otherwise secured’ and those ‘secured by shares of quoted

companies’ made up 48% and 2% of total loans respectively. Previously, Zenith

Bank had a much higher proportion of ‘unsecured loans’. However, after the

recent incidence of high ‘non-performing loans’ (NPLs) that hit the Nigerian

45%58%

43% 49%36%

13%

21% 48%46%

60%

42%

21%9% 5% 3%

0%

20%

40%

60%

80%

100%

2006 2007 2008 2009 2010

Overdrafts Term loans Others

Zenith Bank loan mix: 2006 to 2010



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banking landscape, the bank significantly reduced unsecured loans from an

average of 29% the previous four years to 4% in FY2010. On the other hand, we

are wary of the liquidity of real estate assets used as collateral, as the real estate

market arguably has not fully corrected after the bubble of recent years. Also, the

prevalence of unoccupied properties in choice locations and potential large scale

offload by the Asset Management Corporation of Nigeria (AMCON) could

heighten the glut in that sector.

As a result of the recent industry wide audit exercise by the CBN, we do not

expect a significant impairment in the assets of Zenith Bank over our forecast

horizon. Also, the recent mandate of AMCON to purchase impaired assets from

banks may see an improvement in asset quality. Due to the low proportion of

unsecured assets, Zenith Bank is likely to significantly benefit from AMCON’s

purchase of banks’ assets because impaired secured assets are being

purchased at face value, compared to 5% value for assets without collateral.

Non Performing Loans (NPL) and Provisions

Historically, Zenith Bank had kept its NPL ratio relatively low. Between FY2006

and FY2010, NPL averaged 3.4%, though it was largely pushed upward by the

6.5% and 5.9% reported in FY2009 and FY2010. A review of the NPL from

FY2006 shows an upward trajectory until FY2009, which reflects the build up of

the crisis the industry was gradually climbing into.

Non-performing loans increased from NGN9.6 billion in FY2008 to NGN48.4

billion in FY2009, while NPL ratio rose from 2.04% to 6.5% over the same period.

Zenith Bank loan security: 2006 to 2010


39%22%

49% 46% 47%

0%

0%

3% 6% 2%25%

37%

30% 29%48%

36% 41%

18% 19%4%

0%

20%

40%

60%

80%

100%

2006 2007 2008 2009 2010

Secured against real estate Secured by shares of quoted companies

Otherwise secured Unsecured


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In FY2010, Zenith Bank’s NPL of 5.9% was the lowest amongst peers, and lower

than the peer average of 7.3%. UBA had the highest NPL of 8.8%, while First

Bank and GTBank had 7.6% and 6.7% respectively.

In FY2010, Zenith Bank made a total provision expense of NGN4.35 billion,

compared to NGN39.9 billion the previous year and a combined NGN13.7 billion

between FY2006 and FY2008. However, FY2010 could have been higher by

about NGN7 billion if the 1% general provision on performing risk assets was not

suspended by CBN and the National Accounting Standard Board. Cumulative

provision as at FY2010 was NGN32.77 billion, a 33% decline compared to

NGN49.1 billion the previous year, which reflects the NGN25.4 billion capital

market loans sold to AMCON during the 2010 financial year, reversed provisions

and write-offs of NGN4.7 billion and NGN7.7 billion respectively.

In our analysis, we estimated Zenith Bank’s NPL ratio to average 3.5% over the

forecast horizon. Though we expect the NPL to fall to 4% in FY2011 as a result

of AMCON’s purchase of NPL and regulatory directive of 5% maximum NPL.

The provision coverage ratio was 0.74x in FY2010, averaging 0.92x over the five-

year historical period. The coverage ratio measures provision made by Zenith

Bank for every naira of NPL. Therefore over the historical period, Zenith Bank

provided 0.92 kobo for every naira of NPL. Zenith Bank’s coverage fell from

1.02x in FY2009 to 0.74x in FY2010 because there was a 33% decline in the

cumulative provision (identified above), while there was only a 9% decline in

NPL. Among peers, Zenith Bank’s coverage ratio was lowest at 0.74x in FY2010,

7.6%

6.7%

8.8%

5.9%

7.3%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

First Bank GT Bank UBA Zenith

NPL ratio Peer average

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

-

10,000

20,000

30,000

40,000

50,000

60,000

NPL (NGN'm) NPL Ratio

Zenith Bank Non Performing Loans: 2006 to 2010 Peer comparison of NPL ratio: December 2010

Source: Company reports, WSTC Estimates Source: Company reports, WSTC Estimates


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while GTBank had the highest at 1.01x. The peer average was 0.85x in FY2010,

compared to 0.70x in FY2009.

In our analysis, in line with the provisioning culture of Zenith Bank and the

expected implementation of the newly issued Prudential Guidelines by the CBN,

coupled with the purchase of NPLs by AMCON, we modelled the coverage ratio

to average 1.00x over the next five financial years.

Loan-Deposit match

Zenith Bank’s ‘deposits’ as a ratio of its ‘loans & advances’ averaged 2.11x

between FY2006 and FY2010. It declined to 1.68x in FY2009 as ‘loans and

advances’ increased by 59%, while ‘deposits’ dropped by 1.3%. An analysis of

the loan portfolio maturity profile shows that 54% of Zenith Bank’s loans were

‘over 12 months’ in FY2010, which strongly correlates the earlier assertion that

the bank now has a large proportion of its loans concentrated in longer tenor

term loans.

As at December 2010, the funding side of the balance sheet showed a

concentration of ‘deposits’ in the maturity profile of ‘under 1-month’ and ‘over 12-

months’, which represents 44% and 51% of total deposits respectively. Since the

gross value of deposits is 77% higher than loans, there seems to be no

significant mismatch, in the utilization of deposit liabilities in creation of ‘loans &

advances’.

-

0.20

0.40

0.60

0.80

1.00

1.20

-

10,000

20,000

30,000

40,000

50,000

60,000

Provisions Coverage ratio

0.86

1.01

0.81 0.74

0.85

-

0.20

0.40

0.60

0.80

1.00

1.20

First Bank GT Bank UBA Zenith

Coverage ratio Peer average


Zenith Bank Provisions & Coverage ratio: 2006 to 2014e Peer comparison of Coverage ratio: December 2010


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Therefore over the period forecasted in our analysis, with the expected 15% and

17% CAGR in ‘deposits’ and ‘loans & advances’, we do not expect any significant

disruption in the funding of Zenith Bank’s loans & advances.

Financial Performance

Earnings

Zenith Bank’s gross earnings grew at a CAGR of 35% between FY2006 and

FY2010. The growth rate in earnings was very aggressive in FY2008 when

Zenith Bank changed its financial year from June to September. Therefore the

15-month earnings grew 123% over the previous 12-months, while on a 12-

month annualised basis it grew by 75%. This was also the case in FY2009

when the financial year was again adjusted to December from September, and

earnings grew 5% on an annualized basis, compared to 31% on a financial year

basis. It is important to note that the historical period under review coincided with

the economic boom before the recession in the global economy.

Therefore in our model, we tempered the growth rate for Zenith Bank’s earnings

over the forecast horizon. We expect gross earnings to grow at a CAGR of 18%

over the next five years to reach NGN448 billion by FY2015.

Historically, Zenith Bank had been efficient in converting its gross earnings into

operating income and as a result, operating profit grew in similar trend to gross

earnings. With a CAGR of 32%, operating profit grew from NGN50 billion in

24%

9%

3%

10%

54%

44%

4%0% 1%

51%

Under 1 month 1-3 months 3-6 months 6-12 months Over 12 months

Gross value of loans and advances by maturity Maturity profile of deposits

Loans & advances VS Deposits by maturity: December 2010



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FY2006 to NGN152 billion in FY2010. However, the entire growth in gross

earnings did not translate to growth in operating income because interest

expense grew at a CAGR of 36%, which was slightly above the 33% CAGR

growth recorded by interest income and other income. Operating income is

expected to grow at a CAGR of 17% over the forecast period.

The decline in the operating profit margin from a high of 85% in FY2006 to a low

of 68% in FY2009 reflects the slower growth in operating profit compared to

gross earnings, coupled with the decline in profit as a result of the NGN39.9

billion provision for bad and doubtful loans. However, operating profit margin

bounced back to 79% in FY 2010 as gross earnings declined but profitability

improved. It is estimated to average 82% over the forecast horizon.

Expenses

Zenith Bank’s costs over the historical period under review grew at a CAGR of

31.5%, about the same rate as operating income. The cost structure over the last

five years reflects a relatively stable proportion of depreciation expense, while the

proportion of staff cost and other operating expenses had changed. Other

operating expenses had the highest weight in the cost structure, with an average

of 54%, while staff costs and depreciation averaged 35% and 11% respectively.

‘Other operating expenses’ comprises ‘NDIC premium’, ‘NITDA levy’,

‘Advertisement’, ‘Promotion and Corporate gifts’, ‘Insurance’, ‘Contract services’

Gross earnings, Operating income & Operating profit margin: 2006 to 2014e


0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

-

80,000

160,000

240,000

320,000

400,000

480,000

2006 2007 2008 2009 2010 2011e 2012e 2013e 2014e 2015e

Gross earnings Operating income Operating profit margin


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among others. This expense line gradually declined from a high of 61% in

FY2006 to a low of 48% in FY2009, but then increased to 53% in FY2010.

Among aggregated operating expenses, staff costs rose the most at a CAGR of

37%, which explains why its proportion in the total operating cost structure

increased from 29% in FY2006 to 40% in FY2009. The 9% jump in staff costs

from FY2007 to FY2008 can be explained by the competition in the labour

market for the best brains to drive the bank’s post consolidation strategy, which

therefore led to increased staff remuneration. The rise in staff costs is however

justified by the resilience the bank showed in the face of the crisis that engulfed

the industry.

Depreciation expense also grew strongly over the historical period, at a CAGR of

39%. The previous five years saw a rapid expansion of branch and business

outlet network, thus there was significant investment in assets - properties,

computer software and hardware - to support the growth.

Zenith Bank’s operating expense (OPEX) as a proportion of gross earnings

averaged 48% between FY2006 and FY2010, while cost-to-income ratio

averaged 70% over the same period. Between FY2006 and FY2010, Zenith Bank

gradually reduced its operating expense as a proportion of gross earnings from

its height of 56% in FY2006 to 41% in FY2009, because the denominator, that is,

gross earnings grew at a faster rate than the numerator, operating expense. The

reverse was the case in FY2010 when gross earnings declined faster than

9,614 14,650 33,942

45,443 34,185

3,280 4,793

9,026

13,655

12,162

19,830

28,887

44,594

54,190

51,422

-

20,000

40,000

60,000

80,000

100,000

120,000

2006 2007 2008 2009 2010

Staff salaries and allowancesDepreciationOther operating expenses

29% 30% 39% 40% 35%

10% 10%10% 12%

12%

61% 60%51% 48% 53%

0%

20%

40%

60%

80%

100%

2006 2007 2008 2009 2010

Staff salaries and allowances

Depreciation

Other operating expenses

Cost structure (NGN’million): 2006 to 2010


Cost structure (contribution): 2006 to 2010


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operating expense, thus recording a 10% year-on-year growth in the

OPEX/Gross earnings ratio.

In our analysis, we projected the operating expense as a proportion of gross

earnings to average 42% between FY2011 and FY2015; about 6% lower than

historical average of 48%. On the other hand, the cost-to-income ratio is also

projected to shed about 10% off the historical average, therefore averaging 60%.

The arguments for lower costs are premised on the costs savings expected from

initiatives by CBN to ensure banks reduce operating costs, coupled with the

relative lower interest expense (compared to the boom era) expected over the

next five years.

As at December 2010, peer analysis shows that Zenith Bank’s cost-to-income

ratio of 69% was marginally below peer average of 71%. GTBank had the lowest

cost-to-income ratio compared to industry peers, while UBA had the highest.

0%

20%

40%

60%

80%

OPEX/ Gross earnings Cost to income ratio



Cost ratios: 2006 to 2014e

73%

61%

82%

69%

71%

First Bank GTB UBA Zenith Bank

Cost to Income Ratio

Peer comparison of Cost to Income ratio: December 2010


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Valuation Based on our valuation approach we estimate that Zenith Bank should be valued

at a fair price of NGN14.63, a 1.13% discount to the current share price

(NGN14.80). At NGN14.63, we value Zenith Bank at 1.24x 2011e book, P/E of

9.16x, Earnings Yield of 10.92% and Dividend Yield of 6.83%. To derive the

valuation of Zenith Bank we used discounted cash flow valuation models.

Assumptions

We estimated the discount rate by computing a nominal risk-free rate based on

the 10-year U.S. government bond yield1. The projected difference in U.S. and

Nigeria inflation was added to develop Nigeria nominal risk-free rate. Then using

the CAPM model, we estimated the cost of equity (discount rate) as follows:

Estimated cost of equity ranges from 20.80% to 17.54%. Cost of equity for 2011e

was derived from a risk free rate of 11.82%, equity risk premium of 6% and two-

year beta of 1.50. Beta was modified downwards to 1.33 (adjusted beta) in year

2015e, as the beta value in a future period usually moves closer to the mean

value of 1.0 (the beta of an average-systematic-risk security). Sustainable growth

rate was estimated as 6% (economic growth rate in year 2015e).

To derive the valuation of Zenith Bank we used the following absolute valuation

methods.

Five-year Dividend Discount Model (DDM), and

1 This method of building up nominal risk free rate was adopted due to the relative illiquidity of

certain Nigerian government bonds as compared to more developed markets, and the unusual current scenario whereby blue chip financial institutions and companies are able to borrow at lower rates than the government.

Zenith Bank cost of equity

2011 2012 2013 2014 2015

10-year U.S. bond yield A 2.91% 2.91% 2.91% 2.91% 2.91%

U.S. Inflation rate B 2.17% 1.61% 1.40% 1.66% 1.86%

Nigeria inflation rate, average consumer prices C 11.09% 9.45% 8.50% 8.50% 8.50%

Difference betweeen Nigeria inflation rate and U.S.

inflation rate D=C-B 8.91% 7.85% 7.10% 6.85% 6.64%

Computed nominal risk-free rate E=A+D 11.82% 10.76% 10.01% 9.76% 9.55%

Equity risk premium F 6.00% 6.00% 6.00% 6.00% 6.00%

Beta G 1.50 1.45 1.41 1.37 1.33

Cost of equity H=E+(G*F) 20.80% 19.47% 18.47% 17.98% 17.54%

Sustainable growth rate I 6.00%

Source: IMF, Bloomberg, WSTC Estimates


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Residual Income Model.

Five-year Dividend Discount Model (DDM)

As shown below, the fair value of Zenith Bank using our five-year DDM valuation

approach is NGN14.89, a 0.58% premium to the current share price (NGN14.80).

Terminal value in 2015e was computed as NGN22.34, using the Gordon’s growth

model.

Residual Income Model

As shown below, the fair value of Zenith Bank using our five-year residual

income valuation approach is NGN14.38 a 2.83% discount to the current share

price (NGN14.80).

Appling the same cost of equity computed in the DDM approach above, the

assumptions used to calculate our fair value estimate of the company are

provided below:

Zenith Bank Valuation Dividend Discount Model Approach

2011 2012 2013 2014 2015

Projected dividend per share (NGN) 1.00 1.35 1.69 2.04 2.43

Terminal value (NGN) 22.34

Total cash flow (NGN) 1.00 1.35 1.69 2.04 24.78

Discounting Factor 0.8278 0.7006 0.6014 0.5162 0.4458

PV of total cash flow (NGN) 0.83 0.95 1.01 1.05 11.04

Valuation per share (NGN) 14.89

Source: WSTC Estimates

Zenith Bank Valuation Residual Income Model Approach

2011 2012 2013 2014 2015

Net income per share (NGN) 1.60 2.13 2.61 3.10 3.70

Equity charge per share (NGN) 2.33 2.30 2.33 2.43 2.56

Residual income (NGN) (0.73) (0.17) 0.29 0.67 1.14

Terminal value (NGN) 6.47

Total residual cash flow (NGN) (0.73) (0.17) 0.29 0.67 7.61

Discounting factor 0.8278 0.7006 0.6014 0.5162 0.4458

Present value (PV) of cash flows (NGN) (0.60) (0.12) 0.17 0.35 3.39

PV of total cash flow (NGN) 3.19

Beginning BVPS (NGN) 11.19

Valuation per share (NGN) 14.38

Source: WSTC Estimates


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Summary valuation and Recommendation

To derive our fair value estimate of Zenith Bank, we applied an equal weighting

to the two valuation models outcome above. We then arrived at a fair value

estimate of NGN14.63 (1.13% discount) for Zenith Bank.

We derive a 12-month ex-div target price with the following formula:

Target price = Fair value * (1 + required return) – dividend

The 12-month cum-div target price is derived with the following formula:

Target price = Fair value * (1 + required return)

Using a weighted average cost of equity (required return) for 2012 to 2015 of

18.05%, 2011 dividend of NGN1.00, the target price computation and total

expected return on Zenith Bank is shown below:

Thus, with a total expected return of 16.72% presented in the valuation of Zenith

Bank, we recommend a HOLD.

Zenith Bank computation of target price and total expected returns

Ex-div target price

FAIR VALUE 14.63

12-month ex-div target price 16.27

Current price 14.80

Capital gain on current price 9.97%

Dividend yield on current price 6.76%


Cum-div target price

FAIR VALUE 14.63

12-month cum-div target price 17.27

Current price 14.80


Source: NSE, WSTC Estimates


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Risk factors Some of the major factors affecting the return potential, analysis and valuation of

Zenith Bank, representing both the upside and downside risk factors are

highlighted below:

1) Global economic recovery

The Nigerian economy is exposed to the strength of the recovery in the global

economy. The high dependence of foreign exchange earnings on oil exports,

which is directly influenced by the pace of economic activities around the world,

exposes the country’s finance to the global economy. A sudden drop in oil prices

will affect government revenue, increase deficit, make government to borrow

more which could crowd out the private sector and create inflationary pressure.

In addition, the rising and volatile energy, food and commodity prices in the last

few years have affected disposable income within the citizenry and the

performance of corporate entities.

All of these expose the banking sector (and Zenith Bank) to non-availability of

savings as funds for investment and viable private sector credit outlets.

2) Local economic reforms

While the growth potential of the Nigerian economy is not in doubt, the

inefficiencies of various sectors continue to inhibit the full realisation of the

economic strength of Nigeria.

The speed and extent of reforms in various sectors, and provision of necessary

infrastructure will have a large impact on the future performance of the banking

sector (and Zenith Bank).

3) Banking sector reforms

Zenith Bank scaled the Central Bank of Nigeria (CBN) stress test in 2009, and

has benefitted from the ‘flight to safety’ in the banking industry. The possibility of

a banking sector wide crisis appears low at the moment, since CBN has

minimised uncertainty by compelling banks to report their loss positions and take

the necessary provisions.


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However, the continued support for technically insolvent banks presents an

unequal competitive terrain for the banking industry. The speedy resolution of

recapitalisation efforts of the rescued banks will present a clearer picture of the

status of the banking industry.

4) Quality of security on loans

As identified within our report, 47% of loans in Zenith bank’s portfolio were

secured by real estate. This could represent illiquid collateral, which exposes the

bank to potential losses in the event of a correction in the real estate market. At

present, there appears to be a glut in the high-end of the real estate market and

increased vacancy rate due to loss of investment and reduction in disposable

income for the middle class following the recent financial crises.


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Zenith Bank Financial ModelINCOME STATEMENT (NGN'm)

2008 2009 Dec 2010 2011 2012 2013 2014 2015

Gross Earnings 211,639 277,300 192,488 227,136 274,244 325,253 382,563 447,598

Net interest margin 85,443 109,588 91,546 118,109 138,491 165,877 193,192 223,796

Net fee and commission income 49,511 50,045 46,180 57,870 69,591 80,583 94,782 110,894

Other income 19,288 28,605 14,422 14,823 16,808 20,259 23,829 27,880

Operating Income 154,242 188,238 152,148 190,802 224,890 266,719 311,802 362,570

Operating expense (87,562) (113,288) (97,769) (102,219) (117,934) (136,617) (156,864) (179,055)

Diminution in asset values (10,568) (39,865) (4,353) (15,031) (10,143) (11,847) (14,879) (17,374)

56,112 35,085 50,026 73,553 96,812 118,255 140,059 166,142

Exceptional item (AMCON contribution) - - - (6,484) (7,533) (8,627) (9,813) (11,115)

Profit before taxation 56,120 35,085 50,026 67,069 89,279 109,628 130,247 155,027

Profit after tax 51,993 20,603 37,414 50,301 66,959 82,220 97,684 116,269

Profit attributable to the group 51,609 20,497 37,330 50,174 66,805 82,038 97,469 116,018

BALANCE SHEET (NGN'm)

2008 2009 Dec 2010 2011 2012 2013 2014 2015

Cash in hand and balances w ith CBN 239,562 126,779 141,724 111,686 159,945 204,109 251,429 273,257

Treasury bills 401,445 234,115 298,869 475,387 527,220 574,992 588,638 666,731

Due from other banks 536,846 341,830 399,503 345,831 376,695 431,373 490,689 555,787

Loans and advances to customers 455,324 698,326 713,285 847,826 1,017,391 1,170,000 1,373,774 1,565,704

Other facilities - - 22,536 23,757 25,091 28,733 32,683 37,019

Advances under f inance lease 4,615 5,506 13,188 17,202 21,241 25,762 30,940 36,897

Insurance receivables 816 635 711 - - - - -

Investment securities 64,564 158,977 210,345 227,020 251,208 287,672 327,228 370,640

Trading properties 433 433 7,623 10,855 12,612 14,443 16,429 18,608

Other assets 32,293 13,517 18,936 21,596 25,091 28,733 32,684 37,020

Deferred tax assets 160 966 1,162 1,325 1,540 1,763 2,006 2,272

Property and equipment 50,942 78,619 67,145 78,738 92,989 107,924 124,400 140,903

Total Assets 1,787,000 1,659,703 1,895,027 2,161,222 2,511,023 2,875,504 3,270,900 3,704,839

Customer Deposits 1,188,876 1,173,917 1,318,072 1,512,855 1,770,271 2,041,608 2,338,694 2,667,484

Due to other banks - - - - - - - -

Claims payable 234 198 218 - - - - -

Other facilities - - 26,049 28,863 30,306 31,822 34,115 36,451

Liability on investment contracts - - - 216 502 863 1,308 -

Liabilities on insurance contracts 1,077 1,202 2,287 - - - - -

Current income tax payable 5,690 7,407 3,735 5,500 6,390 7,318 8,324 9,428

Other liabilities 202,114 100,085 145,750 194,508 238,545 273,171 327,088 370,481

Deferred tax liabilities 1,961 3,117 7,380 4,264 4,954 5,674 6,454 7,310

Long- term borrow ings 40,431 35,984 27,975 44,133 64,714 90,502 96,645 115,561

Total Liabilities 1,440,383 1,321,910 1,531,466 1,790,341 2,115,684 2,450,956 2,812,627 3,206,715

Net Assets 346,617 337,793 363,561 370,882 395,339 424,548 458,273 498,123

Source: Company Reports and WSTC Estimates


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Disclaimer & Disclosures

The value of any investment is subject to fluctuations, i.e. may rise and fall. Past

performance is no guide to the future. The rate of exchange between currencies

may cause the value of investment to increase or decrease. Hence investors may

not get back the full value of their original investment.

This document is not an offer to buy or sell any security. This document does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The appropriateness of a particular investment will depend on an investor’s individual circumstances and objectives. The investments and shares referred to in this document may not be suitable for all investors. This document is based on information WSTC Financial Services Limited (WSTC) received from publicly available reports and industry sources. WSTC may not have verified all of this information with third parties. Neither WSTC nor its advisors, shareholders, directors or employees can guarantee the accuracy, reasonableness or completeness of the information received from any sources consulted for this publication, and neither WSTC nor its advisors, shareholders, directors or employees accepts any liability whatsoever (in negligence or otherwise) for any loss howsoever arising from any use of this document or its contents or otherwise arising in connection with this document. This document is not to be relied upon and should not be a substitute for the exercise of independent judgment. This document includes certain statements, estimates and projections with respect to the anticipated future performance of securities listed on the Nigerian Stock Exchange and as to the market for these shares. Such statements, estimates and projections are based on information that we consider reliable and may reflect various assumptions made concerning anticipated economic developments, which have not been independently verified and may or may not prove correct. No representation or warranty is made as to the accuracy of such statements, estimates and projections or as to their appropriateness for the purpose intended and it should not be relied upon as such. Opinions expressed are current opinions as of the date appearing on this material only and may change without notice. Other third parties may have issued other reports that are inconsistent with, and reach different conclusions from, the information presented in this report. Those reports reflect the different assumptions, views and analytical methods of the analysts who prepared them.

Intrinsic Value Estimate

We estimate stock’s fair value by computing a weighted average of projected prices derived from intrinsic valuation methodologies. The choice of valuation methodology (ies) usually depends on the firm’s peculiar business model and what in the opinion of our analyst is considered as a key driver of the stock’s value from a firm specific as well as an industry perspective.

BUY: Estimated total return of the stock is above the current market price by at

least 20%.

HOLD: Estimated total return of the stock is between -10% and +20% from the

current market price.

SELL: Estimated total return of the stock is more than 10% below the current

market price.


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WSTC Financial Services Limited (WSTC) is a Dealing Member of the Nigerian Stock Exchange (NSE) and is registered with the Securities & Exchange Commission (SEC) to conduct Financial Advisory, Fund/Portfolio Management, and Brokerage & Dealing in Nigeria. Therefore, we may deal in any securities listed on the NSE. This document is for information purposes only and for private circulation. No portion of this document may be reprinted, sold or redistributed without the written consent of WSTC. Additional information on recommended securities/instruments is available on request.

WSTC Financial Services Limited registered office is at 2 Maitama Sule Street, South West, Ikoyi, Lagos, Nigeria. Phone: +234(1)4618490, 4619989

© WSTC Financial Services Limited 2011.

Zenith Bank plc - WSTC Financial Services

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