• ROE still-low at 9.1% in 2016e; cut FV and reiterate Neutral rating KFH’s profitability has improved in the past few years, but ROE is still low, at 8.4% in 2015, compared to 6.8% in 2011. The main reason for KFH’s lower profitability compared to its largest peer, NBK, which has an ROE of 10.8% is KFH’s higher operating and provisioning costs burden. We factor in just a slight improvement in ROE to 9.1% in 2016, as we believe that provisioning is unlikely to fall strongly from current levels (cost of risk in FY2015 was c170bps). Valuation multiples are rich in our view, with the stock trading at a P/B of 1.4x in 2016e. We have cut our FV to KWD0.52 (from KWD0.62) as we lower our earnings estimates, and reiterate our Neutral rating, with our FV implying 9% potential upside.
• Potential asset sales could be a source of positive surprises We believe a potential positive catalyst for the stock is potential asset sales, as the bank has said that it is refocusing its strategy in the GCC and as it is seeking to streamline its large investment portfolio. Its Turkish Islamic banking subsidiary, Kuveyt Turk Participation Turk is a core asset of KFH (c30% of assets), but the bank has been considering the sale of its banking subsidiary in Malaysia, which accounts for c5% of assets. We could also see a disposal of investment and real estate associates and/or subsidiaries, but we do not have visibility on the timeline of those and its impact on group earnings.
• Credit quality improving, but provisioning costs unlikely to normalise KFH continues to have one of the highest NPL ratios in Kuwait, at 7.3% in 2015, down from a peak of 12.2% in 2013. NPL coverage has improved gradually, and is now c68% of NPLs, up from 51% in 2013. NPL coverage is c90% when collateral against impaired loans is accounted for. With the Central Bank of Kuwait very keen on banks having strong provisioning buffers, we believe that it is likely that KFH will be asked to take additional/judgmental provisions to increase NPL coverage. NBK’s NPL coverage is 335%.

Elena Sanchez-Cabezudo, CFA
Rajae Aadel