Gulf’s Islamic banks command price-to-book premium

• Sharia-compliant banks lead
• UAE banks beat Saudi peers
• ADIB has highest ratio at 3.5

Investors are favouring sharia-compliant banks in the Gulf, making them the most expensive lenders by price-to-book ratio, an important metric for analysing valuations within the financial industry, an AGBI analysis shows.

At the same time, UAE banks trade at higher price-to-book ratios than their Saudi peers, a premium that Cairo’s CI Capital believes is not justified and which has prompted its researchers to make the kingdom its top regional pick ahead of third-quarter earnings season.

A price-to-book ratio compares a company’s market capitalisation with the net value of its assets. It is calculated by dividing the share price by its book value per share – the amount that would remain if all liabilities and intangible assets such as brand names and goodwill were subtracted from assets.

A ratio above one means investors are willing to pay a premium because they expect the business to grow and profits to rise.

A measure below one may signal a company is undervalued or that investors have little confidence in long-term earnings prospects or balance sheet strength.

“For banking analysis, the price-to-book ratio is more relevant than other valuation metrics such as price-to-earnings because it also adjusts for potential asset quality concerns,” said Chiro Ghosh, vice president for financial institutions at Bahrain’s Sico Bank.

Abu Dhabi Islamic Bank’s (ADIB) price-to-book ratio of 3.5 makes it the most expensive major Gulf bank by this metric, according to data compiled by AGBI.

Saudi Arabia’s Alrajhi Bank (3), Islamic lender Kuwait Finance House (2.3), National Bank of Kuwait (2) and Doha-listed duo Qatar National Bank (1.7) and Qatar Islamic Bank (2) complete the top six.

Ghosh said that sharia-compliant banks tend to command a premium because of strong investor demand. “ADIB has excellent profitability, and its loan book growth has been very solid. It is likely to outperform its peers again this year, according to management guidance,” he said.

In Saudi Arabia, Alrajhi Bank, which is also sharia-compliant, has the highest share of zero- or low-cost deposits within its funding mix, and a large concentration of fixed-rate mortgage loans.

According to Sico’s calculations, for every 25-basis-point interest rate cut, Alrajhi’s net interest margin expands by 4-5 basis points, while those of other Saudi lenders will fall by 1-2 basis points.

Most Gulf countries follow US interest rates due to their currencies’ dollar pegs. The Federal Reserve trimmed rates in September and further reductions are widely expected this year and next.

“That’s why the market remains so positive on Rajhi and assigns it such a high price-to-book value,” Ghosh said.

The cheapest Gulf bank by price-to-book ratio is Arab Banking Corp (0.2), with the Bahraini lender one of six to have a ratio of one or less. The others include Commercial Bank of Qatar (0.7) and Riyadh-listed pair Saudi Awwal Bank and Banque Saudi Fransi (both 0.9).

Sherif El Etr, a banking analyst at CI Capital in Cairo, said that his team compares banks’ price-to-book to the return on equity (RoE). 

If a bank provides the same RoE as its cost of equity its price-to-book ratio should be around one but if it delivers a higher and rising RoE then it should command a premium, he said.

“ADIB, Alrajhi and Kuwait Finance House all trade at premium price-to-book ratios because of their high RoEs. There are other factors that go into it such as profitability, growth outlook and asset quality,” El Etr said.