Credicorp: Caution Warranted Despite Investor Day Optimism (NYSE:BAP)

Admittedly, there were plenty of pros from Credicorp’s (NYSE:BAP) investor day event. Management’s strategic consistency is commendable, and so is its efforts in driving digital transformation across the organization. Concerns around the evolution of payment behavior of clients and the cost of risk were also addressed.

Nonetheless, I think management has baked in too much optimism into the strategy, which does leave room for a downside surprise. Considering the multitude of risks on the horizon (both economic and political), fiscal 2021 is still likely to be a transition year, and I think it would have been more prudent to assume a more gradual normalization to pre-COVID-19 levels. Valuations have admittedly corrected below historical levels, but shares still trade above better-capitalized LatAm peers (Santander (NYSE:SAN), Itausa (OTC:IVISF), Bradesco (NYSE:BBD)) at c. 1.5x P/B.

Broadly Unchanged Strategic Direction

Somewhat surprisingly, Credicorp’s strategy remained mostly unchanged compared to 2018, when management last discussed its medium-term targets. But considering the lower-growth environment we find ourselves in, this likely reflects some optimism on the part of management. For instance, loans are still expected to grow 7-8% from 2022 onwards (only slightly below the 9-10% growth range outlined before). Credicorp is also expecting a swift rebound in Peru’s GDP following a 12% decline in 2020, with an 8-10% growth outcome projected for 2021.

Digital Initiatives Lead the Long-Term Charge

Digital transformation remains at the forefront of the strategy. While the digital shift helps to improve customer experience, I think the key is that it helps the company capture incremental cost efficiencies. At the forefront of the company’s digital innovation push are Yape (over 4 million users for payments) and Cocos y Lucas (FX operations), which will facilitate the target for 70% of all transactions to go digital in three years.

Source: Credicorp 25 Years Presentation

Interestingly, the push for transformation seems to have permeated across the entire company now (compared to 2018), with specific initiatives in place across all four key business lines – universal banking, microfinance, insurance & pension funds, and investment banking & wealth management.

Source: Credicorp 25 Years Presentation

Provisions Remain Elevated

Credicorp expects provisions to move lower in FQ3 but remain similar to FQ1 levels. This reflects the fact that economic growth remains suppressed despite signs of improvement – GDP contracted 12% Y/Y in July compared to -40% Y/Y in April. At present, management is adopting both a top-down and bottom-up approach to addressing provisions, but it is still too soon to say how the reprogrammed loans (c. 24% of the retail loan book) will react from here.

According to management, the aim is to front-load provisions as much as possible so it can focus on driving growth in fiscal 2021. Furthermore, management also expects the cost of risk returning to segment-specific prior levels by 2022, which seems a tad optimistic. On a consolidated basis, the cost of risk is guided to evolve in line with an expected increase in the relative weight of retail loans in the credit portfolios of BAP and MiBanco.

Targeting an Industry-Leading Efficiency Ratio

Each business unit is actively working on capturing cross-unit synergies and meeting ambitious cost-cutting targets to free up resources in the near term. Ongoing initiatives include reducing non-essential expenses and variable compensation. In turn, proceeds from these savings will be used to ramp up growth-oriented investments in digital transformation initiatives to maximize efficiency.

Assuming management delivers on its savings targets, it still has its work cut out in accelerating investments in business transformation, back-office optimization, and development of new distribution channels to drive the targeted long-term upside. The longer-term goal is for the bank to reduce its branch network over the next 8-10 years, while also doubling the size of the loan book – a tall ask considering the company already runs very lean operations relative to peers.

Source: Credicorp 25 Years Presentation

Challenged Margin Outlook in the Near-Term

In the near term, net interest margins (NIM) will remain pressured by lower rates and a greater contribution from Reactiva loans, outweighing improvements in the cost of funding. Management is looking to offset NIM pressure by improving funding costs and shifting the loan portfolio towards retail. However, the structural NIM trend remains under threat amid a lower rate environment in Peru and the US (c. 37% of loans are denominated in USD), a trend which I do not see reversing in the short to medium term.

Furthermore, the loan mix has also been impacted as the bank has stopped originating retail loans due to the COVID-19 impact. This should revert gradually as the economy improves retail lending increases again. However, any recovery will likely be gradual – this contrasts with management’s projections for ROE to rebound to pre-COVID-19 levels by 2022 to c. 16%, as the economy rebounds and the effects of income loss and debt are fully absorbed by the client base. Over the medium term, management guidance calls for ROE to reach the high teens (17 to 19%).

Shareholder Returns to Increase

Total shareholder returns should be maintained close to historical levels, even though a lower-growth outlook could be on the horizon. Instead, the company will offer a higher dividend payout to shareholders. This seems feasible as long as the bank is comfortable with its capital ratios and ROEs return to 16-17% – assuming no inorganic growth, a dividend payout in the 50% range is well within reach.

Source: Credicorp 25 Years Presentation

Encouragingly, management will maintain some conservatism with regard to capital allocation, as no transformational inorganic growth opportunities (investment opportunities at 15-20% of market cap) are planned. Instead, the focus will be on moderately-sized opportunities in niche segments across LatAm regions such as Chile, Colombia, Peru, and Bolivia.

Caution Warranted Despite Optimistic Outlook

Credicorp shares have underperformed this year, as the impact of COVID-19 on earnings and the relatively high levels of uncertainty (both political and economic) continue to weigh on the outlook. I am opting to remain on the sidelines here, as the long-term guidance of 17-19% ROE seems to be on the optimistic side, especially if a slower-growth, low-rate macro backdrop persists.

Furthermore, I am concerned about the execution risk associated with its lower-income-focused retail strategy, considering the mixed results under this approach in the past, especially with regard to asset quality. Shares have de-rated but still trade above better-capitalized LatAm peers (Santander, Itausa, Bradesco) at c. 1.5x P/B.

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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.

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