Credicorp Looks Undervalued, But Its Market Is Slowing

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Credicorp (BAP), Peru’s largest bank in terms of both loan and deposit share, has had a pretty so-so run of late, with the shares down about 5% over the past year, roughly matching the performance of the wider Peruvian market. Although Credicorp’s operating performance has been solid, and Peru’s economy is still in generally good shape, most of the incremental developments have been negative, with a slowing economy and slowing loan demand showing up more recently.

All bets will be off if the global economy tips over into full-blown recession, but at this point it looks like Peru will see a relatively more gentle “adjustment”. The next year may not be the strongest operating set-up for Credicorp, but I do believe the company is still well-placed for above-average growth in the years to come, and I believe management has a credible plan to reach more of Peru’s underbanked citizens and reduce costs, while also carefully expanding outside Peru. I don’t believe Credicorp is dramatically undervalued relative to the above-average operating risk, but I do believe the shares are priced for a relatively attractive low double-digit annualized return.

Will Political Turmoil Spoil A Good Story?

As a country, Peru has been doing well in recent years, with some of the best growth and inflation rates in Latin America. Private consumption has been growing nicely, more Peruvians are participating in the formal banking system, and both debt levels and credit quality have held up well. Even with recent downward revisions in Peru’s forecasted GDP growth rate for 2019 due largely to global trade tensions, the expected 3% or so growth rate (down from earlier forecasts closer to 4%) would still be among the best (if not the best) in the region.

Unfortunately, political turmoil has bubbled up again, threatening the progress Peru has made. Although it still appears that the president, Martin Vizcarra, is popular with most of the public, there has been controversy associated with his move to dissolve Congress ahead of accelerated elections in January 2020. Vizcarra’s move also required him to replace his entire cabinet, with 19 new ministers sworn in last week.

This isn’t the place for a full telling of what has led to this uncertainty, but suffice it to say Vizcarra (generally regarded as a centrist) had been having some meaningful disagreements with opposition politicians over his proposed reforms to root out entrenched corruption. Despite enjoying what looks like broad support from the populace (at least in terms of those who’ve participated in recent referendums), the president and opposition have clashed for over a year. The opposition (many of whom have allegedly benefited from corruption) has claimed that Vizcarra is using this anti-corruption effort as cover to grab power, and they are now trying to challenge his actions through Peru’s top court (the Constitutional Tribunal).

So far it looks like Peru’s military, and a lot of the population, continues to support Vizcarra, but the markets don’t like political uncertainty and protracted instability will eventually spill over into the economy. Credicorp has already warned about slowing economic growth and slowing loan demand, but so far the slowdown looks manageable, with Credicorp still reporting better than 6% loan growth in the second quarter and double-digit growth in consumer/retail lending (though all of this took place before the recent intensification of political uncertainty).

If It’s Not Broken, Don’t Break It

If investors are looking for excitement and dramatic transformation, they need to look elsewhere. Credicorp has a business model that has been working well for the company, and management is looking at only modest fine-tuning adjustments in the near future.

Credicorp has lost a little bit of loan market share (particularly in lower-yielding corporate loans), with Intercorp (IFS) and Bank of Nova Scotia’s (BNS) Peruvian subsidiary looking like the primary beneficiaries (Intercorp posted double-digit loan growth in the second quarter, for instance). Still, Credicorp has close to 40% share of corporate loans in Peru, as well as greater than one-third share of middle-market loans, one-third share of mortgages, and roughly 20% share of consumer and credit card loans, as well as roughly one-third deposit share in a country that is still underbanked.

With Peru’s economy slowing, Credicorp management is continuing to focus on new ways of reaching customers and reducing costs. Almost every bank is talking about expanding its digital offerings these days, and Credicorp is delivering – consumer digital loans have doubled and the company is continuing to spend ($120 million in 2019) on improving its digital offerings to reach more customers and offer more services through digital channels.

Mibanco, Credicorp’s microfinance subsidiary, likewise remains a key part of the company’s retail banking strategy. Credicorp has added new credit evaluation tools and improved analytics, and while Mibanco still has non-performing loan ratios above the company average (6.5% versus 4.1% in the second quarter), the credit trends have been okay so far. Competition has been increasing in this segment, though, and management is actively working to become more customer-centric while also improving back-office operating efficiency.

Credicorp has also been cautious about deploying surplus capital into growing its business outside of Peru. The bank acquired a 75% stack in Colombia’s Bancompartir for $80 million this summer, and management sees meaningful opportunities in the microfinance market in Colombia. Still, management is approaching this market with some caution and will look to use further digital investments to build on this relatively small initial move with Bancompartir.

The Outlook

Business is going well for Credicorp. Net interest income rose 9% in the second quarter after rising 7% in the first quarter, net interest margins are healthy (in the mid-5%’s and rising), and operating costs are under control (up 4% yoy in the second quarter after a <7% rise in the first quarter). Fee income has been a little sluggish, though, and loan growth is slowing – curiously moreso in U.S. dollars than in Peruvian soles. So far that loan slowdown is mostly in lower-yielding corporate loans (which also have higher credit quality), and worries about deteriorating credit quality have not yet shown up in the numbers, though I expect some deterioration in the second half of 2019.

I’m cautiously optimistic that Peru will navigate through this recent political turmoil without totally disrupting what has been an unusual run of economic growth and stability in the country. Still, I do expect 2020 to be softer than 2019 and I think growth will be a little harder to come by. I still expect a ROE in the high teens, though, and loan growth in the high single-digits before some reacceleration in 2021. I’d also note that Credicorp remains well-capitalized, and the company announced a special dividend in late September equivalent to around 1% of the share price ($2.39/share).

I’m looking for low double-digit annualized earnings growth over the next five years, slowing into the high single-digits in the following five years, and management could exceed those expectations on some combination of faster loan growth/increased market share, lower credit losses, lower expenses, and/or more aggressive expansion outside Peru.

Discounting the core adjusted earnings I’m modeling, I believe Credicorp is priced for a low-to-mid-teens annualized return now. I do have a higher return hurdle for stocks like Credicorp (to account for the greater risk), but that return rate is above my hurdle rate, suggesting Credicorp is undervalued.

The Bottom Line

Buying into political turmoil is always risky, but it also can be an opportunity to start positions at more attractive prices. Peru’s economy is in solid fundamental shape now, and while I do think Credicorp will see some pressures in the second half of 2019 and into 2020, I believe the overall loan growth, spread margin, expense, and credit quality trends are healthy. Credicorp does still have above-average risk, but I believe it’s one of the more attractively-priced risk/reward opportunities among Latin American banks now.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.