Grupo Aval: Still On The Right Track To Recover

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Grupo Aval is poised for recovery due to Colombia's improving macroeconomic conditions, interest rate cuts, and a declining inflation rate.The Colombian economy shows signs of recovery with GDP growth...

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Since my first article the stock has traded roughly flat with steady dividends. Despite the lackluster total return, I remain bullish on Grupo Aval and emphasize patience for this name as the Colombian economy begins to turn around. It may take longer than expected, but I still see signs of Grupo Aval's profitability reverting to the mean and expect long-term investors to be rewarded. Rate Cuts Should Stimulate Colombia Colombian interest rates remain relatively high, at 10.75% at the time of this writing. They have been cut steadily from a peak of 13.25%, and word on the street is that the Colombia's central bank is going to be more aggressive with future rate cuts. I expect future interest rate cuts to happen, which would stimulate the Colombian economy and encourage more activity and borrowing, helping banks within Grupo Aval. Inflation is already on the steady downward trend, with further reinforces my belief that aggressive rate cuts in Colombia are coming. At 6.12% for August 2024, the inflation rate has already decreased significantly and therefore high interest rates are no longer necessary in my opinion. Therefore, I think we are seeing a return to normalcy in Colombia, which should revert Grupo Aval's profitability back to its historical average. This may eventually send Grupo Aval's stock back up and give investors a satisfactory return. Trading Economics (inflation rate) And finally, we are seeing GDP in Colombia pick up again in the second quarter of 2024. According to BBVA Research, Colombia's GDP grew 2.1% year-on-year in Q2 2024, exceeding the 0.8% growth in Q1. Domestic demand and investment showed signs of recovery, with household consumption up 1.5% and investment up 4.3%. A 1.8% growth is expected for 2024. Whether it's interest rate cuts, declining inflation rate, and a growing GDP, I remain bullish on Colombia's overall economy and expect a swift recovery within the next year. It has taken a little while, but I think we are seeing light at the end of the tunnel. What this means for Grupo Aval is that their set of banks should perform better going in FY 2025, and the return on average equity should return to the historical average of around 10%, back in 2022 and prior. NIM Has Room To Expand I think that the net interest margin of Grupo Aval has room to expand, as rate cuts may reduce their cost of deposits while potentially keeping their return on assets relatively high. I like how the Central Bank of Colombia is gradually cutting rates at a steady pace, to give banks a chance to adapt and rebalance their liabilities and assets to remain profitable. Management discusses the impact of slow rate cuts on their slowly improving NIM in the earnings call,  The expansion of NIM on loans continues to be slow due to higher funding costs in line with a shy Central Bank intervention rate reduction pace. We expect that the Central Bank will have room to accelerate its pace in rate cuts as the year progresses, given the positive evolution of inflation, the current high forward-looking real interest rate level and the recent reduction in the outlook for U.S. rate levels. This scenario supports our view of NIM expansion over the following quarters.  The case for NIM expansion is compelling, and we are already seeing a tiny glimpse of it in the recent second quarter earnings results. NIM increased a tiny bit overall in Q2, with \"The total NIM of our banking segment expanded 3 basis points to 4.3%, driven by the same trends impacting our consolidated NIM\". To me, this is just the beginning as an improving Colombian economy does add fuel for Grupo Aval to return to solid profitability and a consistently improving NIM to around 5%. Finally, the guidance that management gave seems to be more optimistic than usual, signaling their confidence that rate cuts can really improve their banking business. Management says, \"We expect loan growth between 7.5% and 8% with commercial loans growing between 9% and 9.5% and retail loans growing between 5% and 6%\". The fact that commercial loans are expected to grow faster than retail loans tells me that business is picking up again in Colombia, and that eventually this may be reflected in higher NIM for Grupo Aval going to FY 2025. Declining Cost Of Risk Is Bullish In Q2 2024, I noticed a sharp drop in the overall cost of risk for Grupo Aval, both for consumer and commercial loans in their presentation.   Investor presentation Grupo Aval comments in the improvements in their cost of risk in the earnings call, The lower cost of risk in commercial loans incorporates an improvement in credit ratings of previously deteriorated corporate clients that have had overtime a consistent good payment behavior. This explains improvements of 36 basis points in total cost of risk and 68 basis points for commercial loans during the quarter. This is yet another sign that Colombia is on the path to recovery. Their corporate clients have seen their business pick up again, so they are willing and able to make those interest payments consistently. According to the presentation, in particular it's the energy companies in Colombia that are seeing business back in action. ROAE increased from 2.7% to 4.9% from Q1 2024 to Q2 2024, and the market has yet to recognize the gradual improvement in Grupo Aval's business. In conclusion, a holistic view of the numbers reveal that a declining cost of risk signals an improvement in the creditworthiness of Colombia's businesses, which reinforces my thesis that Colombia is coming back slowly and should help lift up Grupo Aval's profitability. Price Target Unchanged - $3 Fair Value I leave my price target from before unchanged, at $3 fair value per share. Using new data but the same valuation method from my last article, I will project flat average equity and the projected 6.5% ROAE in the earnings call to predict the future earnings of Grupo Aval.   Investor presentation Assuming average equity remains at 16.7 trillion Colombian Peso, ($4 billion), I think that earnings will come in at around $260 million assuming a 6.5% return on average equity ($4 billion x 0.065 = $260 million). Apply a FWD sector median earnings multiple of 12x gets me $3.12 billion in market cap. Divide by shares outstanding of 1.19 billion gets me $3 fair value, rounded up. The reason why I rounded up is because I think the ROAE will continue to increase as the Colombian economy improves. So, the 6.5% expected ROAE is too conservative and will likely reach double-digits over the long term. So, I still believe that $3 is the fair value of the stock and that Grupo Aval is a good buy at these prices. Risks Colombia is a volatile economy with a current-account deficit and falling investment. It also has an overreliance on oil, and if oil prices collapse further than we could see GDP growth slow in Colombia. In any case, any slowing down of the Colombian economy could invalidate my thesis that the overall business and economic environment is recovering, which could lead to a stagnant share price for Grupo Aval. Also, rate cuts could happen too slow and cause the recovery to take too long for investors, leading to a potential unsatisfactory return on investment over too long a period of time. Competition in the banking sector is always intense, and competitors such as Bancolombia (CIB) are also incredibly profitable and have good growth prospects, as I covered in my article here. Investors may find that other choices are perhaps superior to Grupo Aval, leaving AVAL's share price in the dust. Buy Grupo Aval  I still like this name as it pays out good dividends monthly, and is a solid banking stock that is poised for recovery over the long term. I think Colombia is slowly coming back based on all publicly available economic metrics, and that inflation, unemployment, and GDP are all headed in the right direction. Further rate cuts from the central bank in Colombia should stimulate this recovery even further, and eventually be reflected in higher ROE for Grupo Aval.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2472308323"}