The negative views of investors regarding the Central Bank of Egypt’s (CBE) decision requiring banks to retain profits and not to make any dividend payouts for the fiscal year 2020 prompted a wave of selling in the Egyptian stock market, hitting shares of the biggest Egyptian banks causing the Commercial International Bank’s (CIB), one of the largest players in the banking sector, shares to fall to its lowest levels in 10 years’ time. The question is: Are Egyptian banks really as weak as the stock prices suggest and shouldn’t be invested in? Or is it just an overblown reaction that doesn’t reflect the economic and financial reality of the Egyptian banks?
The status quo
Egyptian banks are traded in the stock market at prices that do not reflect the reality of their financial situation. The downward trend of interest rates on Egypt’s treasury bills with a likely decrease of 2-3 percent (calculated on basis of the real interest rate i.e. the difference between the nominal interest rate specified by the CBE and the inflation rate) is considered a stimulating factor that suggests possible improvement in the banking credit sector. Hence, despite their low market prices, there are a number of factors that provide a positive optimistic outlook for Egyptian banks including, first, the sustained ability of Egyptian banks to generate profits during COVID with a net income average growth rate of 13 percent (excluding Housing and Development Bank), a rate that makes the banking sector one of the highest profit margin sectors in the Egyptian Stock Exchange; second, the increase in the loan to deposit ratio (LDR), expected to reach 60 percent in the year 2021, given this year’s tend of falling interest rates; and ,third, the positive expectations of the working capital adequacy ratio, which promotes financial stability and banks’ viability.
Egyptian banks’ shares are traded at a price-to-book value of 0.93x (Price per share/ book value per share) and have an earnings multiplier of 5.3x (Price per share/ earnings per share) for the year 2021 – two metrics that compare valuations of banks in different geographical areas to find undervalued or overvalued shares. Analysis of Egyptian banks’ stocks indicates the sector’s ability to achieve a compound annual growth rate (CAGR) of 16.5 percent and a return on average equity (ROE) of 17-19 percent in the period from 2021 to 2024. Comparing those metrics for Egyptian banks to the same metrics of Gulf banks, we find that Egyptian banks are traded at a price-to-book value of 1.7x and a profitability multiplier of 15.6x (the lower these values are, the lower the bank’s price is and the more attractive its price is). As for the ROE, Gulf banks have a ROE of 13.5 percent, down 3.5 – 5.5 percent from Egyptian banks, which means Egyptian banks are cheaper than Gulf banks. Even when considering a worst-case scenario where the return on treasury bills (deposit and lending rates) won’t go lower than they are today and hence borrowing rates will not increase (banks’ negative impact on credit), these valuations will stay positive as banks will be investing in treasury bills and getting high net interest margins, a scenario that had been experienced before in the period of rising interest rates from 2016 to 2019.
Looking at the financial results of the Egyptian banks in the last quarter of 2020, we find that their combined net profits grew by about 13 percent (excluding the Housing and Development Bank whose profits fell by almost 22 percent). Moreover, the net interest margin (difference between interest paid and interest received) is expected to decline by approximately 69 basis points towards an average of 5-5.8 percent in 2021 and 2022. As for the dividend payouts for FY 2021-2022, they are projected at about 35 percent (up from actual distribution of 23 percent in 2019)
Banking sector’s performance in the Egyptian exchange
Considering the banking sector performance in the Egyptian Exchange, we find that the index was at its lowest level in a year’s time standing at 795 points, down from 903 points last February, implying a decline of 12 percent in less than two months. As indicated above, this selling wave in the banking sector isn’t justifiable considering it is one of the economy’s strongest sectors capable of maintaining continued profits in times of crises (as has been evident during COVID-19 pandemic in 2020) achieving a profit margin of 13 percent (excluding the Housing and Development Bank).
All together, these factors indicate that the Egyptian banks are undervalued (their market price is lower than their real value) which gives them attractive valuations. Moreover, the legislative framework and the economic environment in Egypt offer many opportunities that support banks viability, including the trend toward expanding in small and medium enterprises which required that banks increase their loan portfolio by five percent to account for 25 percent of total credit portfolio by 2022. Also, the CBE’s decisions to eliminate fees on ATM withdrawals and bank transfers till June 2021 and suspend dividend payouts for the fiscal year 2020 as well as its initiatives that will open up new horizons and opportunities of growth in the banking system including the EGP 100 billon worth Real estate Appraiser for low and middle-income earners with a decreasing interest of 3 percent and a payback period of up to 30 years in the medium term will reinforce the sector’s growth. Given the high rates of net interest margin in both initiatives (medium and small projects and the real estate appraiser), they are likely to contribute to improving the profitability of banks and making investing in banks a win-win deal.