In a different era or market Diamond Bank will be worth about N19 by my estimates. However, the market and its prevailing sentiments are not so ideal so the share price is stuck at an average of N6.5 about 30kobo less than what it was 5 years ago. To make matters worse it is offering its shareholders a right to buy shares at a “discounted” price of N5.8. In fact, after the offer and when the new shares would have been added to the old its theoretical ex price will be N6.36 creating a 9.6% upside for shareholders if the price doesn’t go down. As a shareholder deciding whether to take up his rights or not, the thought of another flat share price growth and what could happen if the market suddenly decided to value the shares better puts me in a near state of flux. Thankfully, I have a few metrics I’d like to share which could decide whether I buy or not.
What are they using the money for?
Diamond Bank claims it needs the money for the following reasons;
- Development of the Bank’s IT infrastructure
- Supporting the Bank’s working capital
- Expansion and refurbishment of the Bank’s business locations
Well, if you familiar with bank Public offers and Rights Issue of the past this is not new. As far as I am concerned this is all geared towards shoring up their capital, particularly its capital adequacy ratios (CAR) which have averaged 17% since 2012 against the statutorily required 15%. The bank said this much in it’s 2013 FY annual reportCover1
Our Bank had a total CAR of 18.0% as at 31 December 2013 and we expect to further boost CAR by the end of 2014 to create a sufficient buffer over and above any prevailing regulatory minimum. In addition, the potential introduction of the computation of banks’ regulatory capital based on Basle II and III, for which the CBN commenced a pilot scheme in January 2014, will put new pressures on the Bank’s CAR. Consequently, we need to be proactive in positioning our Bank to surmount any challenges that may arise if the new regulations are implemented.
So this is basically about shoring up capital which really isn’t a bad thing. This takes me to the next question
1. P.E Ratio – This is an obvious no brainer. At a current (pre rights issue) P.E ratio of 3.3x Diamond Bank’s current price look undervalued. It’s hard to imagine a Tier 2 bank trading below 4x its earnings per share. At that price the earnings yield is an astonishing 30%. Hard to beat that.
2. PEG Ratio – It’s hard to use the PEG ratio when a stock has a negative compounded annual growth rate. So, if we assume Diamond Bank grows its earnings per share at 1% compounded annual growth rate it gives an obvious PEG of 3.3x making it look expensive. Currently, it is hard to predict annual growth in EPS for banks beyond 3% adjusted so even that makes the PEG ratio look like 1.04x by my estimates. Off course the PEG ratio is correlated to the share price so this we have to be mindful of that. At the current Rights Issue price PEG will be less that 1x (which signals a buy)
3. Dividend Yield – Diamond Bank hasn’t been a fantastic dividend paying bank in the last 5 years having only paid twice in 2010 and 2013. Nigerian stock market is also majorly dividend driven so we have to bear that in mind. Its dividend yield is about 4.5%. It’s poor dividend yield is due to its relatively small dividend payout ratio. Last year it only paid out 15% of profits as dividends as it chose to retain more profits so as to boost capital. It probably might double that this year, now that it is raising fresh capital of over N50billion. If profits remains flat this year (at N30billion) and it pays 30% of profits out as dividends then I estimate dividends per share based on post rights issue outstanding shares to be about 40kobo per share. So, if I apply a yield of 5% to that I get an estimated share price of N8. Now that is an upside of about 30% on the current price. This is not far fetched if you ask me.
4. Discounted Cash Flow – I have adjusted the share outstanding to reflect the post Rights Issue share price in this valuation. I also assumed flat EPS growth rate and discounted the future earnings per share by 20%. It’s a high discounted factor, however on the back of the banks risky assets I have to expect that much in returns. Despite this conservative approach I arrive at a value of N12.4.
5. Volume of trade – Diamond Bank like most bank is a highly liquid stock so there is no problem with exiting the stock when I want to. However, the high volume leads to high volatility too. So I am weary of that.
6. Share Price Growth Rate – Diamond Bank like I mentioned hasn’t performed well with capital appreciation. The advantage here is that it just has to drive up sooner rather than later provided it continues to post profits. However, that reward needs a lot of patience and that’s till next year in my opinion.
Market – Diamond Bank is a leading Tier II bank and will probably continue to do so. How it does that will depend on its ability grow its capital base organically. It’s also not far off Tier 1 status as the banks in the class currently don’t have Net Assets below N230billion. This rights issue will give the bank a Net Asset of about N200billion. It also has a large presence in the SME market.
Board & Management Team – They have a sound and experienced management team led by Dr Alex Otti. However, rumored board squabbles in recent times may have a positive or negative impact on their performance depending on your vantage point. I also hear the MD is set to leave the bank come year end.
Opportunity – The bank can continue to lead the way as it has in the mobile banking space. Retail banking is also a huge market for the bank based on its ability to deliver cheap deposits and higher yield risk assets. These come with inherent risk but it is an opportunity they can’t ignore if they are to survive. It’s either they take risky bets or remain redundant.
Ironically, I had considered putting up this stock up for sale during my most recent portfolio reclassification exercise where I wanted to reduce my exposure to the financial sector. My stockbroker advised me not to suggesting that I reconsider, pointing at the Rights Issue price as a key factor. This prompted this analysis.
Taking all of this into consideration, I have decided this a BUY. I will take up my rights accordingly.