Nairobi: September 3, 2010: Conviction buys

Kenya Commercial Bank

September 3, 2010 closing price: 18.95

52 Week High: 23.00

52 Week Low: 17.65

P/E Ratio: 9.75 (June 30, 2010 Q2 Results)

P/B Value: 1.57

ROE 16.07%

Dividend yield: 5%

Investment case

Strong capital position (most capitalised bank in Kenya): the Kshs 12.3 Billion raised in a recent rights issue will enable the bank to double its already huge loan book.

Cheapest NSE listed bank on a P/E valuation basis. The current price is close to its historical bottom: there is minimal downside and significant upside potential.

The high dividend yield is a cushion against unexpected price drops.

Biggest regional branch network. Well placed to leverage from the ongoing East African economic integration. Wide branch network facilitates mopping up of cheap deposits.

Risks

High cost structure: KCB has one of the highest cost to income ratios in the industry.

Regional execution risk: regional reach has not always led to great performance. KCB’s Tanzania subsidiary has been making losses for years. While profitable, the Sudan subsidiary is exposed to the huge political risk in the volatile country.

Stiff competition in the industry. Equity bank has captured a big share of the low income market and looks to gain even more share in this market through its innovative ‘Mkesho” partnership with Safaricom. Smaller banks such as NIC, CBA, I&M and DTB are providing a more personalised service to upper middle and middle class income segments of the population.

Jubilee Holdings

September 3, 2010 closing price: 194

52 Week High: 210.00

52 Week Low: 113.00

P/E Ratio: 12.10 (June 30, 2010 Q2 Results)

P/B Value: 2.43

ROE 20.11%

Dividend yield: 2%

Investment case

Regional reach: Jubilee has insurance businesses in Kenya, Uganda and Tanzania.

The current rally at the Nairobi Stock Exchange should lead to a huge gain in the company’s substantial investment portfolio.

Low insurance penetration in East Africa: there is a huge untapped growth potential.

Risks

Entry of banks into the insurance/insurance agency business. Banks have a natural outlet through their existing branch networks.

Insurance business is dependent on too many variables any of which could have a devastating effect on the bottom line. A fall in stock prices will hit investment income/gains. A rise in interest rates and the attendant fall in bond prices will similarly have a huge negative impact on investment portfolio valuations. Any of unexpected catastrophes, fraudulent claims, and mispricing of insurance risks could easily cause a substantial underwriting loss.

KenolKobil

September 3, 2010 closing price: 9.30

52 Week High: 11.00

52 Week Low: 9.00

P/E Ratio: 5.80 (June 30, 2010 Q2 Results)

P/B Value: 1.14

ROE 19.57%

Dividend yield: 3.5%

KenolKobil is the riskiest of the conviction buys but is likely to yield the highest medium term returns.

Investment case

KenolKobil has the second largest petroleum products distribution market share in Kenya.

The share price has fallen to such an extent that the company is now valued close to the break-up value of its assets. KenolKobil’s market capitalisation is now Kshs 13.6 Billion compared to Kshs 12 Billion book value of its assets.

Stable world oil prices should ensure decent gross margins for the rest of the year. Crude oil prices have traded in the 71-78 range for most of 2010.

KenolKobil has spread its operations to several countries in East and Southern Africa. The company has operations in Kenya, Uganda, Zambia, Tanzania, Rwanda, Burundi and Ethiopia and has been targeting acquisitions in Zimbabwe and Mozambique. The non-Kenyan operations have been profitable and are reducing the company’s dependence on its home market.

Oil majors such as BP, Chevron, and Mobil are exiting retail business to deploy their capital on the more lucrative oil prospecting and drilling business. It is this exit across Africa that has enabled KenolKobil to expand market share in Kenya and acquire new businesses in the region. This is a trend that is likely to continue.

Risks

As per the most recent half year results KenolKobil has a huge short term debt (Kshs 11 Billion) which it is using to finance its working capital. Should any of its huge debtors delay payment, KenolKobil could easily face liquidity issues.

Global crude oil prices can easily fluctuate to the detriment of gross margins. If the crude oil prices drop steeply KenolKobil will be forced to offload stocks that had been acquired expensively at lower prices triggering an operating loss.

The ongoing dispute with the Kenya Petroleum Refinery and the Energy Commission is likely to impact the Kenyan operation negatively. A revocation of KenolKobil’s Kenyan retail licence (a real possibility) will have a huge impact on overall profitability as the bulk of the company’s profit still comes from Kenya. It is this regulatory overhang that has been a damper on the company’s share price even after reporting fantastic half year results.

Disclosure: I hold Kenya Commercial Bank shares