IFS - Credicorp Executing Well But Macro Risk Remains High

Summary

• Credicorp's fourth quarter results were better than expected at the pre-provision line, but higher provisioning drove a miss for net income.
• Management is taking a more conservative stance on credit, noting some signs of weakness in real estate and tourism.
• Credicorp continues to see growth in its digital businesses, while competitors are getting more aggressive in corporate lending.
• Peru's political unrest threatens to spill over into the economy, as protests disrupt tourism and mining operations.
• Credicorp is undervalued on long-term growth of around 10%, but macro issues in Peru are a near-term issue for sentiment.

I’ve used the “good house in a difficult neighborhood” analogy before with Credicorp ( BAP ), and it remains valid today – this Peruvian bank is a very well-run bank and one with above-average growth prospects, but political (and potentially economic) turmoil remains a significant challenge for sentiment and will, at some point, spill over into the operations unless the government of Peru can find a path out of its current crisis. Thus far, the shares have held up alright, declining modestly since my last update .

It will take time for Peru to get back to some semblance of normal, but in the meantime two of the country’s main engines of economic growth, mining and tourism, are vulnerable to ongoing social unrest. I do still believe that Credicorp can generate around 10% long-term core earnings growth from here, and that it is undervalued on that basis, but investors considering the shares today should at least go in with their eyes open to the macro risks here.

A Good Quarter On A Core Basis, But Higher Provisions Are A Concern

Credicorp’s core results were better than expected in the fourth quarter, but there were some warning signs, including slowing loan demand and rising provisions, with management getting more cautious on the economic outlook.

Revenue rose 22% year over year and 6% quarter over quarter, with net interest income driving the growth. Net interest income rose about 31% yoy and 8% qoq, beating by around 5% (different third-party services reported different “consensus” numbers for the quarter), with net interest margin up almost 150bp yoy and 42bp qoq to 5.73%. Earning assets fell about 3% sequentially.

Fee income declined 3% yoy and 4% qoq, while insurance earnings rose 44% yoy and fell about 7% qoq.

Operating expenses rose 11% yoy and about 16% qoq reported. Pre-provision profits rose 37% yoy and fell 3% qoq, beating by about 3%. Provisions, though, were much higher than expected, driving pre-tax profits down 18% qoq (up 1% yoy), missing by about 6% to 9%.

Slowing Growth And Rising Non-Performing Loans

Overall constant currency structural loan performance wasn’t too bad, rising close to 12% yoy and about 4% qoq, only a modest deceleration from the sequential growth in the third quarter. For the Peruvian operations, though, loans were up less than 1% sequentially versus the 5%-plus growth in the prior quarter, with particularly noticeable slowdowns in business lending.

Corporate lending was down about 2% qoq, while small/medium-sized business lending slowed to the low single-digits. Consumer lending growth remains in the low single-digits on a sequential basis, with Mibanco slowing from about 4% qoq growth in the third quarter to less than 3% qoq growth this quarter.

Given higher rates (Credicorp’s average loan yield improved 180bp yoy and 50bp qoq to 9.9%) and growing concern about the economy in 2023, it’s not so surprising that loan demand is slowing. At the same time, I think it’s worth monitoring the performance of competitors – BBVA ( BBVA ) and Bank of Nova Scotia ( BNS ) (“Scotiabank”) have both been getting more aggressive in going after Credicorp’s nearly 40% market share in corporate lending. I also find Intercorp ’s ( IFS ) efforts on the retail and digital side to be interesting. I’m more concerned at this point by the credit situation.

Non-performing loans rose 10% sequentially, with the structural NPL ratio climbing slightly (3bp) to 4.95%. Mibanco’s NPL ratio actually improved meaningfully on a sequential basis, from 6.5% to 5%. Cost of risk jumped 85bp qoq to 2.06%, with Mibanco up 320bp to 5.9%, as management takes a more conservative stance on credit. Management pointed to increased signs of weakness in the corporate business from businesses in the real estate and tourism sectors, and does sound more cautious overall about the business climate in 2023.

Political Risk Will Eventually Become Economic Risk

Credicorp is doing well with the things it can control. It has maintained strong share in a wide range of lending categories while simultaneously maintaining good risk control and expanding its lending to smaller businesses and microfinance customers. There are a few areas where Credicorp punches below its weight (credit cards, most notably), but competing for more share against Intercorp and Scotiabank may not be worth the risk and cost.

Credicorp also continues to leverage its digital efforts. About two-thirds of its customers use the bank’s digital tools for half or more of their transactions, and Yape continues to grow nicely, with a 42% sequential increase in users and an 84% sequential increase in active users. Not only is Credicorp starting to monetize Yape (largely through transactions and marketplace services), it’s expanding its digital offerings on Culqui (its acquiring/POS platform) and moving forward with a new digital bank offering for affluent customers.

All of that is great, but there are bigger events underway in Peru. The arrest and impeachment of former president Castillo has not only put the country’s sixth president in place within the last five years, but also sparked violent protests across the country (more in the southern areas). Protests have led to the closure of Machu Picchu and disruptions to the mining industry, and the U.S. State Department and Britain’s government both now advise caution with respect to traveling to Peru.

A resolution seems distant at this point. Some of the protestors are talking about themselves as an insurgency, and in multiple cases the government has treated them as such, leading multiple ministers of Boluarte’s government to resign in protest of the government’s use of violence to quell protests. Meanwhile, although the populace seems to support new elections in 2023, the congress seems reluctant to move on this, with elections currently scheduled for 2026.

I’m hopeful that something can and will be done soon to bring the violence to an end, but Peru’s congress is politically fractured and there’s a big disconnect between those in congress and those protesting. Unless congress can find a path to accelerate new elections, I’m not optimistic about a quick resolution and it will start to impact the economy of Peru.

The Outlook

This isn’t the first time that Peru has had internal disruption, though this is the most serious example in a long time. I do think that Credicorp will make it through in good shape, but a disrupted economy definitely creates modeling and earnings risk for the next year or two (if not longer). Assuming that some resolution can be found within the next year, I believe Credicorp will generate close to 10% annualized core earnings growth from 2022’s ending point.

Discounted back, those earnings support a fair value in the low $160’s, and I get a similar fair value ($165) on the basis of my ROE-driven P/TBV approach.

The Bottom Line

Investors have to decide for themselves if they’re comfortable with the risks around Credicorp at this point. I do think that, absent the protests, the outlook for Peru’s economy beyond 2023 would be positive, and I like Credicorp’s opportunities in digital banking and smaller business lending. I also like the track record of execution here. The macro risks are not trivial, but I do think Credicorp is undervalued on a longer-term basis provided that ongoing unrest doesn’t derail Peru’s economy for a long period of time.

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