TCS Group - Battening Down, But Getting Through It

These are unquestionably challenging times for TCS (Tinkoff) given its strong focus on retail financial services and consumer lending and given that clarity over how this year is going to play out remains low. Sifting through the main issues that can affect the business at this time, we think that Tinkoff will get through the Covid-19 crisis in decent enough shape to bounce back strongly over the next couple of years. We also think that when trying to look through the current shock, Tinkoff is the kind of financial services company that we would want to own longer-term: online, highly tech-focused, well-managed and logically building out an ecosystem beyond financial services, although we recognize that for now it feels more like a case of battening down the hatches. We cut our 2020 and 2021 earnings forecasts by 38% and 17% and roll out our model to 2022, when we think Tinkoff will post above 30% ROE. We cut our target price by 30% to $19.00 per GDR, incorporating lower earnings estimates in 2020-21, a longer valuation period, a weaker ruble and a higher cost of equity due to the US tax charges against the founder and controlling (in voting terms) shareholder, Oleg Tinkov. The 1Q20 numbers and call (May 13) will provide a clearer picture about the immediate impact of the crisis, and while near-term we expect some volatility, on a 12-month view we retain our BUY on the stock. > Liquidity and capital still look solid. When banks are hit by a sharp shock such as the Covid-19 lockdown (not to forget the plunging oil price), thoughts first turn to liquidity and capital. On the former, Tinkoff looks very solid, with stable deposits in March and April, around R180 bln of cash and securities (corresponding to around 30% of the total balance sheet), and an 80% loan/deposit ratio at end-2019, and we expect liquidity to build up through this year as deposit inflows remain fairly robust while loan growth slows strongly (turning negative for the full year). The capital position under IFRS is very solid, with an almost 16% Basel 3 CET1, a leverage ratio of just 6 and R91 bln tangible CET1 equity (end-2019) underpinning just R384 bln in gross loans. Under the far more onerous RAS regime, we think Tinkoff could post moderate losses in 2Q/3Q20 and still remain above an 8% CET1 this year. We also note that Tinkoff had over R5 bln unrecognized gains on securities at end-2019, and the RAS numbers imply some chunky recognized gains in January-February, which should provide some counterweight to rising provisions. This all said, we think the prudent path on dividends would be to hold off for at least the next quarter. We model a resumption of dividends for 4Q20. > Asset quality - P&L can withstand a major hit. We think Tinkoff could manage a substantial rise in provisioning this year and remain profitable, with a breakeven cost of risk around 19% on our numbers. So far, it appears the shock to asset quality has not been that dramatic, with the early spike in delinquencies easing off, and well under 5% of the loan book restructured, with a small share under the more onerous official government payment holiday terms. Nevertheless, we expect Tinkoff to provision conservatively in 1Q20 on deteriorating IFRS 9 macro inputs. We expect risk costs of 13-14% in 1Q-2Q20, and the cost of risk to remain elevated at 12.5% for 2020 before dropping to around 9% in 2021. Each additional 1 pp on cost of risk this year takes about R3.5 bln off earnings. > Revenues and costs to adjust to the changed environment. The real revenue impact of the current environment will only be seen in 2Q20 and beyond, and early indications are of SME turnover and card transaction volumes taking a 20-25% hit. Forecasting fee income is fraught with difficulty, but we expect a sharp drop in areas such as merchant acquiring, interchange, FX transactions and SME in 2Q20, with the booming brokerage business a rare bright spot. Overall, we think F&C income growth will remain in positive territory in 2020, but just barely (3% growth). That said, we think that Tinkoff looks well placed to bounce back in 2021-22 on this line, and as a pure online operator with an impressive ecosystem being rolled out, it should benefit from strong secular growth in card and online transactions. We project 28% and 23% fee income growth in 2021 and 2022. On the other key revenue line, net interest income, we expect some additional downward pressure on margins from payment holidays and modest deposit rate rises, and we bake in about 350 bps of NIM decline to 17.8%. Each 50 bp drop in NIM hits earnings by about R2 bln. Costs are an area in which Tinkoff is relatively well placed to adapt well to the changing landscape, operating without the encumbrance of a branch network, and with customer acquisition costs typically making up 40% of total costs. With loan growth likely to slow sharply as Tinkoff tightens up on underwriting - we project a 2% decline in gross loans in 2020 - we think Tinkoff can keep nominal costs pretty much flat in 2020, with cost/income declining to around 36.5%. > Earnings to drop over 25% this year, but ROE to recover to over 30% in 2021/2022. We expect 1Q20 to showcase the strength of Tinkoff's business heading into a likely much more challenging period on the revenues side; we project R8.6 bln net income, up 23% y-o-y. We anticipate that 2Q20 and 3Q20 will be much tougher for earnings (around R5-6 bln net income per quarter) and see Tinkoff generating about R26.6 bln this year, down 26%, though this would still imply very decent 25% ROE. Clearly, visibility on how Russia's economy will evolve this year is very low (we project a 4-7% decline in GDP). We expect it to bounce back in 2021, but it is very unclear by how much, and the recovery path for Russian consumers may not be straightforward. We therefore see the rebound in earnings back to a more sustainable level more likely in 2022 than next year. We model R39.5 bln and R53.5 bln net income in 2021 and 2022, the former about 10% below the consensus and the latter 5% above, with 32% ROE in 2022. > Crisis can be a springboard for market share gains. The 2014-15 crisis in Russia proved something of a springboard for Tinkoff to strongly grow its market share in retail banking. We suspect the same may be true of this crisis, given that banks with strong online platforms are best placed to benefit from changing consumer habits and a likely step up in cashless transactions, and Tinkoff is the leader of the pack here. We wait with interest to see data coming through of how online and banking behavior change over the coming months. > Oleg Tinkov US tax case can still hurt the stock. Amid the current global crisis, the event that sparked the plunge in Tinkoff's share price in early March seems to have almost been forgotten. The next court hearing is now set for July 13; moreover there has been little further communication regarding Tinkov's health. While we think the operational impact on the business is minimal, the brand is clearly strongly linked to its founder, and the negative corporate governance implications and risks around stock overhang contributed alongside the current limited operational visibility to a 200 bp increase in our cost of equity to 18%. We don't underplay the risk that further negative headlines relating to this case could hurt the stock, and we think that a partial further stake sell-down (Tinkov owns a 40.4% economic stake and 87% voting stake) is possible. > A good financial services company to own post-Covid 19; still a BUY. Our updated valuation includes the extension of our forecasting period to 2022, the higher cost of equity, a weaker ruble (USD/RUB 75) and cuts to our 2020-21 earnings assumptions. We use a 30% long-term ROE and derive a 2.0 target P/BV multiple. From this, we derive a $19.00 per GDR target price, down 30% from our previous target, and we retain our BUY recommendation on the stock. We sanity-check this with a P/E-based valuation. Given the limited earnings visibility, for now we apply the historic average P/E (7.1) to our 2021 earnings, which gives a very similar fair value. Longer term, we think there is a case for applying a higher P/E multiple, particularly if non-credit lines again become an increasingly important driver of the revenue story. On our numbers, Tinkoff trades on a 2.1 2019 P/BV and a 7.5 and 5.0 2020 and 2021 P/E, with the latter looking an attractive level and not too far off historic lows. We realize that there is a great deal of uncertainty surrounding our forecasts and the economic outlook for Russia more broadly, but we think Tinkoff has the key ingredients of balance sheet strength and resilience, operational flexibility boosted by its online model, and strong and stable management that has successfully negotiated the path through powerful shocks to the business before in order to manage its way through this crisis. Ultimately, in our view, Tinkoff remains the kind of financial services company one should want to own longer-term. > Valuation. Having rallied late last year and in early 2020, the shares have de-rated sharply over the past couple of months. The stock trades on a current P/BV of about 2, compared to a trough multiple of just below 1.0 in autumn 2015, and on a consensus one year forward P/E of around 4.5, which is close to the trough of early 2014, although earnings visibility into next year remains low.