• 1Q16 earnings surprise on spreads, better non-interest income Al Rajhi Bank’s 1Q16 earnings rose 3% Q-o-Q to SAR2,017mn, 8% above our forecast of SAR1,862mn. The earnings recovery was propelled by a strong improvement in net interest spreads, and steady growth in non-interest income. We estimate Al Rajhi’s net interest spreads rose 9bps Q-o-Q. While funding costs are unlikely to have changed significantly, spread improvement in 1Q16 suggests that asset yields are gradually recovering. This is the second consecutive quarter of spread improvement, and gives us confidence to take the view of a gradual recovery. The government has recently started issuing Shariah-compliant instruments under its bond programme. The investment book switch from shorter-dated instruments into bonds should also be supportive for spreads, in our view.
• 2016 kicks off on a strong note as loan growth accelerates Loan growth momentum accelerated in 1Q2016, likely helped by a pickup in retail credit demand. Loan growth was sluggish in 2015 at 2% Y-o-Y, which was the slowest growth for Al Rajhi since 2009. The maturity in the corporate loan book in 2H15, which led to a 9% Y-o-Y decline in corporate loans, had also weighed on net loan growth. We expect loan growth to accelerate to 7% Y-o-Y in 2016. Management has recently started focusing on re-establishing its presence in the corporate lending segment, looking selectively at opportunities. While this is likely to be negative for spreads, it should support above-sector average loan growth at Al Rajhi.
• Valuation premium reflective of improved profitability; stay Neutral Trading at c2.0x 2016 book value and 12x 2016 earnings, Al Rajhi’s valuations are at an almost 80% premium to the sector average. While stronger spreads should help sustain ROEs around15-16% in the near term, we believe this is largely reflected by the stock’s premium valuations. We tweak our 2016-18 earnings estimates, and lower our fair value to SAR54.0. We reiterate our Neutral rating on the stock.

Murad Ansari