Credicorp Stock: Shaking Off Pandemic, Back To Business As Usual (NYSE:BAP)

The past six months or so have been pretty good ones for Peru, with copper prices at a decade-long high and the overall economy recovering from the pandemic-driven downturn. Better still, my concerns about the government that I raised in my last article on Credicorp (BAP) haven’t come to pass – while I’d still argue that President’s Castillo’s preferred/espoused policies are bad, he hasn’t been able to actually do much and it seems like the Congress of Peru is holding the line.

Since that last article, Credicorp shares are over 50% higher, handily beating U.S. banks, the broader Peruvian market, and most other Latin American banks as well. I continue to believe that this is a well-run bank with good leverage to under-banked Peruvians, and still priced for double-digit returns, but I wouldn’t expect the same pace of gains in the near term.

2022 Will Have Some Core Growth Headwinds

Looking at the two biggest drivers of most bank’s top-line performance, net interest margin and loan growth, Credicorp’s outlook for 2022 is mixed.

Management guided to 8% to 10% “structural” loan growth in 2022, and is currently outgrowing the banking sector, but loan growth will be impacted by the run-off of Reactiva loans and there is some vulnerability here to higher energy prices. The good news on the Reactiva side is that these are such low-yielding loans, the run-off won’t really hurt the business, and Credicorp should still see net loan growth comfortably in the high mid-single-digits (around 6% to 7%).

As far as spreads go, Credicorp will benefit from replacing low-yielding Reactiva loans with higher-yielding regular lending, but the bank is not particularly asset-sensitive, meaning that higher rates don’t generate as much growth in the yields of the loan portfolio. Management said that a 100bp move in rates would only drive an expected increase of around 6bp-7bp in net interest margin, or a roughly 2% move in net interest income.

Given the nature of Mibanco funding (wholesale deposits) and the loan book, particularly the retail/consumer loans, this isn’t likely to change all that much. That said, rates did already go up 275bp in 2021 and should go up more than 100bp in 2022, and there should be some benefit from eventual balance sheet repricing.

Expense Leverage Is A Bigger Driver

The one area where Credicorp was a little weak in the fourth quarter was on the operating expense line (up 12% yoy and qoq), and that limited operating leverage in the quarter and drove a small miss at the pre-provision operating income line (which was made up for by lower provisioning).

Expense growth should moderate in 2022-2024, and if it does, the combination of high single-digit to low double-digit net interest income growth (driven mostly by loan growth, but some spread improvement) should be enough to drive high-teens to low-20%’s pre-provision growth over the next three years.

“Should” is the tricky word here. Management has been investing a lot of money into building up the bank’s digital capabilities and it has yet to result in meaningful operating leverage (an issue seen at other banks making big digital investments, including ING Groep (ING) in Europe). While I do think this will improve, I also wouldn’t fault management for wanting to continue to invest in building out the capabilities of Yape, as this digital wallet is off to a strong start and could ultimately be a very cost-effective tool for reaching and servicing the largely-unbanked Peruvian retail market.

One other “expense” driver is provisioning. Management responded aggressively at the start of the pandemic by significantly bulking up its reserves, but actual bad debt experience during the downturn was better than feared. That’s leading to unsustainably low cost of risk in the short term (0.34% in Q4’21 versus a long-term average of around 1.5% to 1.7%), but I believe there’s still more reserve adjustment to come, and that should help support earnings in 2022 and 2023.

The Outlook

In contrast to recent experience, I expect Credicorp to see its large commercial lending activities slow a bit, while consumer lending demand picks up. Current global macro issues (namely, higher energy prices) are a bit of a threat in the near term, but I’m not really worried about the overall outlook over the next three years there. I also expect to see good ongoing business growth trends at Mibanco and with the Yape app, though monetization of Yape is still likely a couple of years off.

I do still see macro risk in Peru; while the President may not be making much headway with his campaign initiatives, cycling through four prime ministers in a brief span doesn’t exactly scream “stability”. At the risk of sounding a bit cynical, though, it’s not like Peruvians haven’t learned how to function through extended periods of political turmoil, so though I do have some concerns about the operating environment for banks (higher taxes, more regulation, et al), the on-the-ground experience may not change as much as I fear.

As far as Credicorp’s earnings outlook is concerned, I do expect high teens-to-low-20%’s pre-provision profit growth over the next three years, and I’m expecting core earnings to grow at a compound rate close to 15% over the next five years and above 10% over the next 10 years. Given the lessons of history, it’s almost certain that growth won’t come in a smooth stepwise climb and there will likely be bumps along the road.

Discounting those core earnings, I still think Credicorp is priced for double-digit annualized total returns, though the near-term potential per ROE-driven P/B and P/E isn’t as exciting. Based on historical norms for the region, Credicorp should trade at around 1.65x – 1.75x book based on my ROE estimates of 15% to 16% over the next two years, but the shares are already close to 1.7x and 9.5x on my ’23 EPS estimate isn’t undervalued relative to other LatAm banks.

The Bottom Line

Clearly the market is feeling better about the situation in Peru. While there is also some risk, I suppose, from the transition to a new CEO (Gianfranco Ferrari), he is not a newcomer to the bank and I don’t expect any significant change in the basic operating philosophy or strategic plan. All told, I think Credicorp remains one of the best-run LatAm banks and a name still worth considering if you’re comfortable with the situation in Peru, though I do think the share price may see some short-term headwinds.