TCS Group - 10 Things We've Learned From Recent Numbers

In this note, we focus on 10 interesting things we've learned from the recent results and business updates from TCS Group (Tinkoff). Since we incorporated modelling of the impact of Covid-19 in late April and reiterated our BUY call, the stock has risen over 30%. While visibility on various fronts remains low, most of the data points to an improvement in the operating environment in May and June as economic activity starts to recover. While we expect bumps along the way, we stick to our view that Tinkoff's advanced online ecosystem should help make it a long-term winner from this crisis. We make only minor adjustments to our forecasts (5%/1%/0% EPS increases in each of 2020-22) and incorporate a lower risk-free rate and stronger ruble into our valuation. This gives us a $23.00 per ADR target price, and we reiterate our BUY recommendation. > (1) Customer acquisition has accelerated in lockdown. Tinkoff has been adding customers at a tremendous clip both early this year and throughout the lockdown. One million new Tinkoff Black accounts were added in 1Q20 (including 50,000 from the wind-down of Rocketbank) and another 460k in April, helped by generous cashback offers for new customers who make online purchases. Tinkoff Investments now has a market-leading 1.8 mln registered clients and has broken even. Overall, active clients rose from 10.3 mln to 10.8 mln in 1Q20. The network of couriers remains busy these days, with 26k daily meetings, which is not far below the 30k average prior to the crisis. > (2) New opportunities opening up. The lockdown has tapped into some new pockets of demand that may provide longer-term growth opportunities. These include the new virtual Tinkoff Black card, which is akin to a prepaid e-wallet, expanding the online acquiring network (Tinkoff is the number three player in this segment), an increased uptake of new online banking clients and the ability to open investment accounts remotely even for non-existing customers. > (3) Client activity recovering. Data from both Tinkoff's CoronaVirus Index and Sberbank's SberIndex suggest improving consumption and transaction metrics. No one knows for sure what is to come, but the 20% y-o-y drop in fee income in April for VTB and Sberbank looks like the nadir, and we note Sberbank's fee income improvement in May (+7% m-o-m/-13% y-o-y), which we would expect to be largely mirrored at Tinkoff. > (4) Overdue loan dynamics improving, credit card coverage high. As of 1Q20, less than 6% of the loan book had been restructured and, according to the bank, overdue loan dynamics have been improving in recent weeks, although levels are still above pre-crisis times. We think a repeat of the 16% cost of risk seen in 1Q20 is unlikely for 2Q20 (we have 13.3%, and 6% of the 1Q20 figure was for macro adjustments). We also note that provision coverage of the credit card book was just below 20% in 1Q20, very close to the 21% peak in 2014. > (5) Funding costs keep falling and can go lower. Average funding costs dropped to just 4.8% in 1Q20. For some perspective, that is only 50 bps higher than for VTB, whereas at end-2016, for example, Tinkoff's average funding costs were 10% versus VTB's 6.6%. As the CBR has been signaling further rate cuts, we think Tinkoff's funding costs can potentially fall further, and it has already dropped its Tinkoff Black and current account rates from 5% to 4%. What is also important here is that Tinkoff has been reeling in new customers and deposits even as it lowers rates.> (6) Falling acquisition costs highlight model's flexibility. Customer acquisition costs fell 9% y-o-y in 1Q20, helping to bring the cost/income ratio below 33% (adjusted for securities sale gains) and highlighting the flexibility of the business model. The lockdown has also vividly highlighted the advantages of not having to manage a branch network and all the safety precautions (and additional costs) that now go with that. > (7) Confident enough to pay dividends. We were surprised by the decision to pay dividends for 1Q20, but with the results coming out in mid-May, the management clearly felt confident enough to make this call at that stage. We think April is likely to have been the low point of RAS profitability (just R100 mln net income), but even including the annually updated operational risk charge, CET1 at the start of May was 9.3%, which looks comfortable enough, while the IFRS Basel 3 CET1 is a strong 15.5% and leverage just 6.3 times. > (8) Awash with balance sheet liquidity. Strong new account openings seem to be translating into deposit growth, further boosting a very robust liquidity position. Retail deposits rose over 6% in April alone and were up over 13% in February-April, compared with the Russian market's 4% growth. With the loan book basically stagnant or in decline, the issue Tinkoff faces is how to manage its excess liquidity. We see the share of securities and cash in total assets rising to over 45% by the end of 2020. > (9) Stock liquidity has picked up greatly. Tinkoff's 100d ADT has pretty much tripled YTD, rising to around $15 mln, roughly two-thirds of which is in the local Moscow Exchange-listed ADR, of which the company says around 30% is retail investors. It appears the stock is increasingly becoming a proxy for retail investor activity in Russia, no doubt supported by its own brokerage operations. > (10) Even after the rally, it's still cheap for what it is, even given the risks. We have only tweaked our model assumptions after the 1Q20 IFRS and 4m20 RAS results, raising our 2020-22 EPS forecasts by 5%, 1% and 0%, respectively. In terms of valuation, we incorporate our updated house exchange rate (USD/RUB of 71, down from 75) and trim our cost of equity by 1 pp to 17% on a lower average long-term risk-free rate. This pushes up our target price from $19.00 to $23.00 per ADR. Even after a more than 50% rally since April's lows, Tinkoff only trades on a 2021E P/E of 6.1. This still looks inexpensive to us for a fintech business that has over 10 mln active customers, has a proven scalable online business model and which remains highly profitable. We sanity-check our GGM valuation with P/E multiples: at our target price: Tinkoff would trade on a 2021E P/E of 8.2, which we think feels fair given ongoing risks. We see the opportunity to bring the cost of equity down further as Russian bond yields and interest rates decline, but we still think there are near-term risks on several fronts for the banking sector. Banks, including Tinkoff as a retail-focused financial services company, still face a lot of uncertainty in terms of the economic outlook and path to recovery in Russia, which we try to incorporate in our valuation, and our strategists remain cautious on this sector above all others. There is also the unresolved matter of Oleg Tinkov's US tax trial, which could impact the stock in the coming months.