Global values Burgan Bank at KD1.050 and recommends a BUY on the stock.

Summary: Global Investment House -- Kuwait -- Burgan Bank (BB)- Investment Update -Burgan Bank (BB) exhibited a continued vigor in its yearly bottom-line escalation with a 34%YoY growth in its net income in 2007, which was reported at KD74.8mn for the said year.

* Global values Burgan Bank at KD1.050 and recommends a BUY on the stock

Global Investment House -- Kuwait -- Burgan Bank (BB)- Investment Update -Burgan Bank (BB) exhibited a continued vigor in its yearly bottom-line escalation with a 34%YoY growth in its net income in 2007, which was reported at KD74.8mn for the said year. The bank stood amongst the top 5 banks of Kuwait (by profit) for the year under review, albeit, its advances and deposits base, were the 6th highest within the country. The bank's top-line however declined by 4%YoY, similar to some of its peers but profit growth stood robust given the 60%YoY surge in non-interest income during the year. Albeit, interest income surged 29%YoY, the interest expense grew by a much higher 53%YoY, leading to the current stagnancy witnessed in the top-line. Figures would have reflected a much better situation had the KD10.6mn charge to the interest income not come about in the 4Q07, reducing the interest income by 5.9%. The charge was due to an adjustment to the loans portfolio that had their terms modified during the year in accordance with the instructions of the Central Bank of Kuwait, whereby estimates of future cash flows of interest income were revised (discounted at original rates of interest).

Based on the current market price of KD0.950/share, Burgan Bank is trading at 2008E P/E and P/BV multiple of 12.7x and 1.9x respectively. Our estimated value for this banking scrip is worked out to be KD1.050 based on Dividend Discounted Model (DDM) (80%) and adaptation of the Gordon Growth Model (20%). According to our fair value the banking scrip offers an upside of 11% over the closing price of KD0.950 per share (as of August 25, 2008). We therefore reiterate our BUY recommendation on the scrip.

As per our calculations carried out through the volume-spread analysis, we come to the conclusion that in 2006, the bank's net interest income (NII) was driven by both volumes and spreads whereby the impact from both sources was almost in equal proportions. In 2007 however, the coupling effect was absent with the volumes and spreads having opposing effects on the change in NII. Notwithstanding the fact that impact from volumes almost doubled over the previous year, it was not enough to offset the effect of the sharply declining spreads. Spreads shrunk by 73bps during 2007, on account of a 29bps increase in the yield on earning assets and a 103bps increase in the cost of funds. Another perspective views the same figures after catering for or adding back the impact of the one-time charge on the interest income. Having done so, we still conclude that the actual increase in the NII came from volumes since spreads still declined and had a negative impact on the change in the NII. While the total impact on the NII changes from a decrease of KD2.3mn to a rise of KD8.3mn, the direction of impact of the individual factors remains unchanged. Difference arises in magnitude however, whereby catering for the one-off charge pronounces the amplified impact of the volumes on the NII while the negating impact of the spreads decreases. We further conclude that the decline in spreads was lower, standing at 29bps, had the one-time adjustment not come about.

Following a tapering-off in the top-line, Burgan Bank addressed the issue of a potential decline in the profitability, with a prolific rise in its non-interest income, which grew 60%YoY. Since fee income diminished by 14.5%YoY, other income which grew to a sizeable KD5.4mn in 2006 got reduced to a mere KD0.9mn in 2007 and dividend income grew by a low 15%YoY, capital gains helped support the bottom-line, growing almost 10-folds during the year. Capital gains in the vicinity of KD24mn stemmed from Burgan Bank's sell-off of stakes in entities and from trading activities. The motive behind realizing capital gains emanated from the bank's plans to raise capital for possible acquisitions of foreign banks, in order to bring them under one umbrella. Moreover, as was the case in most banks, the forex gains increased substantially, and in Burgan's case in particular, the forex gains grew a 116%YoY, contributing 11% of the change in non-interest income.

Even though Burgan Bank's cost to income ratio (before provisions) in 2007 improved over the previous year, reported at 26.4%, its efficiency ratios still stand on the higher side, as compared to its peers. Dissecting the components of operating cost further, relates that the component of the ratio related to staff expenses actually improved YoY from 13.6% of total operating income in 2006 to 12% in 2007 given a marginal rise of 6.5%YoY in staff costs. This improvement was however nullified to some extent by the second component that collectively represents all other costs including depreciation and general and administrative expenses. This cost grew 28.6%YoY and as a percentage of total operating income, grew by 90bps to 14.4% in 2007. Furthermore, excluding the one-time charge on interest income, which shows a more accurate picture of the bank's cost-controls, it is revealed that the efficiency of the bank in fact improved significantly, exhibited by approximately 310bps decrease in the said efficiency indicator over 2006.

The bank's total assets swelled by a huge 29%YoY, reaching KD2.8bn in 2007 and exhibited the highest growth rate achieved since 2002. The growth in total assets was led exclusively by a rise in loans & advances, which surged by 52%YoY. The bank parked any excess liquidity in T-bills and bonds which grew 12%YoY, in order to earn the next best yield available after loans and from a less risky avenue. Burgan Bank's gross loans and advances grew by a staggering 52%YoY driven purely by corporate loans in the wake of gross retail loans growing by a lower yet healthy 18%YoY. An 83%YoY jump in corporate loans therefore steered the loan book forward. The contribution of corporate loans to total gross loans, as a result increased from 72% in 2006 to 80% by the end of 2007.

The asset quality of Burgan Bank has improved significantly over the years as visible from its NPLs/Gross Loans ratio which has come down from 6% in 2003 to 3.6% in 2006 and further down to 1.7% in 2007. Burgan Bank's NPLs ratio therefore stands at one of the lowest seen in the Kuwaiti banking sector and speaks volumes of the bank's effective risk-management practices, implemented 4-5 years ago. The bank's provisions remained stagnant on a YoY basis given a decline in specific provisions offset by an almost equal increase in its general provisions. Burgan bank therefore provided a trivial KD0.3mn in provisions during 2007 as compared to KD6.1mn in 2006. The coverage ratio of the bank thereby increased from 128% in 2006 to 165% in 2007 attributable to a combination of declining NPLs and stagnant total provisions (increasing general provisions).

Burgan Bank reported a net profit of KD46.9mn (EPS: 49.5fils) for 1H08 generating a bottom-line growth of just 2%YoY. Factors behind the sluggish bottom-line movement can be pointed out as stagnant top-line and dull non-interest income growth. When viewed from the perspective of the bank's operating/core performance, that is, its performance after adjusting for major one-off items like capital gains from the post-provision operating profit, figures relate that Burgan Bank, actually exhibited a growth of 31%YoY. Net interest income in 1H08 dropped by 5%YoY despite handsome growth in average earning assets, given a sharp shrinkage in the Net interest margins (NIM) during the period under review. While the average interest earning assets grew by 25%YoY in 1H08, the NIM shrunk by 59bps over 1H07, leading to the said decline.

Burgan bank is a small sized bank that has used its size to its advantage by becoming more flexible, than its large-sized peer, to the dynamically changing environment it operates in. The bank has effectively achieved risk management excellence visible from a sharp decline in its classified loans portfolio, successful revamping of it branches across Kuwait and an overhaul of its practices and policies over the years. After profitably incorporating best practices, the bank is aiming at growing across geographies into the MENA region with the acquisitions of Jordan Kuwait Bank (acquired as of July 14, 2008), Tunis International Bank, Algeria Gulf Bank and the Bank of Baghdad, all subsidiaries of the KIPCO (principal sponsors of Burgan Bank) owned United Gulf Bank. Though this seems like a move by the KIPCO Group, to consolidate its banking assets under one umbrella, the synergies formed across boundaries, movement and inculcation of Burgan's expertise and experience gathered so far into in subsidiaries, franchise diversity and economic diversification will translate into further profitability for the bank. Furthermore, it will lead to a greater balance sheet for Burgan Bank itself and hence enhanced per party limits in addition to a boost to the bottom-line from its newly acquired subsidiaries.

Burgan Bank is anticipated to exhibit a decent growth going forward. Top-line improvement is expected to be supported by strong volumes while spreads are expected to stay under pressure till 2009 and to increase beyond that. A 2007 -- 2011 CAGR of 22% in the top-line is therefore expected to result in a CAGR of 17% in the bottom-line over the same period which coupled with a high payout averaging at 71% explains our liking for the bank. 2008 Al Bawaba (www.albawaba.com)