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Saudi banks | More than a flow story; NCB, Al Rajhi top picks

Broad-based recovery ahead. Positive developments have been taking place since the 2018 onset, be it on the macro front (higher oil prices, signs of pick-up in economic activity, and improved project execution) or in the banking sector. We have seen: i) higher credit activity (7M18 loan growth at +2.2% vs. +0.9% in 7M17), ii) increasing asset yields, reflecting positively on banks’ NIM (+20bps y-o-y in 1H18), and iii) asset quality metrics stabilising. For 2019, we expect further pick-up in lending growth (7.6% vs. 2.4% in 2018e) and deposit growth (6.8% vs. 2.1% in 2018e). We also project further NIM expansion (+20bps on average), as banks continue to capitalise on the higher interest rate environment. From a trading perspective, the MSCI Saudi Arabia upgrade to an EM status (effective mid-2019) will support banks’ (9 members of the index) potential rerating, we believe (average upside for our OW calls is 27%). The average 2019e P/B is 1.35x for our Saudi banks coverage, while our implied valuation is 1.64x vs. the historical peak of 2.24x.

Favour top two lenders; NCB at a more compelling valuation. NCB stands out as the key beneficiary of an improvement in appetite for credit (top market share of corporate loans of 18%), supported by a strong balance sheet (liquid, cheap funding,  short maturity for assets), with its solid capitalisation and asset quality (CAR=20.3%, NPLs=1.7%), shielding it from deterioration in its Turkish business (3.7% of equity). NCB’s 2019e RoE of 18.8% tops our Saudi coverage, along with Al Rajhi (RoE: 19.6%, P/B 2019e 2.5x), while trading at 20% discount to the latter. Al Rajhi should continue to trade at a premium, given its superior profitability, asset quality, capitalisation, and lending focus. We expect Al Rajhi and NCB to capture c55% of the potential passive flows into banks, resulting from the MSCI Saudi Arabia EM upgrade. 

Also positive on Samba and AlJazira. Samba is a corporate-oriented, clean, liquid, and efficient bank that is primarily constrained by a highly conservative lending strategy. The current economic backdrop will likely push Samba to start adopting a more aggressive stance, helping narrow its valuation gap to peers. AlJazira remains a good value proposition amid its turnaround story, which started to materialise. AlJazira is also a beneficiary of higher stock market flows (contribution of brokerage fees to non-interest income at 23%, 3x peers). We like the standalone story/valuation of SABB, but note that the pricing of AlAwwal merger is in favour of the latter (implying sustainable RoE of c13% vs. our base case valuation: 10.7%).  

Recent regulatory changes; drag on AlBilad. Based on our analysis, Al Rajhi, SABB, and AlAwwal should be least impacted under IFRS 9 vs. names such as ANB and AlBilad, in terms of future provisioning. Separately, retail-focused lenders (particularly AlBilad, fastest-growing in 1H18), Al Rajhi, and AlJazira are to be most impacted in the short-term by the new retail regulations. We also note that the Zakat issue is still ongoing, but expect the final impact on banks will be contained. ANB and AlAwwal will be the least hurt from the debacle, while we see no impact on NCB.