Picture: REUTERS
Picture: REUTERS

Participating in the Barclays PLC sale of more than one-third of South African-listed Barclays Africa Group (BGA) catapulted the latter into a top 10 share across most of Allan Gray’s client mandates, almost overnight. Simon Raubenheimer, portfolio manager at Allan Gray, discusses the investment case.

Earlier this quarter, Allan Gray clients had the chance to participate in a rare opportunity: on May 31 2017, UK-based Barclays PLC announced the sale of 33.7% of Barclays Africa Group (BGA) for R37.7-billion. The placement price of R132 per share was at an almost 10% discount to the closing share price on the day before the announcement and the average price over the preceding month. At short notice our clients got to invest a substantial sum of money in a decent asset at a great price.

Barclays’ history with Barclays Group Africa

The lion’s share of Barclays’ investment in what was then called Absa was made in 2005 at R82.50 (or £8 per share from their perspective). A further investment was made in 2013 (share price £9.50), coinciding with a name change to BGA. By March 2016, Barclays – now under a new CEO – reversed course and announced its intention to sell the bulk of its 62.3% in BGA. A chunk was sold off in May 2016 at £5.80/share, and the recent sale at £7.80 will leave Barclays with about 15% of BGA (soon to be called Absa?).

From Barclays’ perspective, its investment in BGA has been disappointing:

  • In British pound terms, we estimate Barclays generated marginal positive returns after accounting for BGA’s generous ordinary and special dividends and R12.8bn of separation fees.
  • Barclays’ investment would have lagged the South African FTSE/JSE all-share index by at least 5% per year. It is staggering that in early 2009, at the trough of the global financial crisis, the 320-year-old Barclays – with more than 100,000 employees around the world and assets of £1.3-trillion – had a market value, excluding its stake in Absa, that was lower than the latter bank’s. At the time, Absa had total assets of only £60bn, less than a twentieth of Barclays’. Just seven years before, Barclays was 35 times bigger than Absa, as shown in the graph below. The performance of our banks during the global financial crisis is testament to the stability of our banking system.

The South African banking sector

Our major banks have all grown their earnings faster than the market over the long term, and the banking sector overall has done well for all stakeholders. We are not oblivious to the challenging economic climate facing the banking sector. Weak economic growth and political instability are legitimate concerns. Rating downgrades carry economic consequences through higher capital costs and lower returns on equity for the banks. However, these concerns are well known and widely publicised.

Importantly, however, the fundamentals underpinning the South African banking system have not changed. It is vital not to lose sight of the long-term picture amid all the noise and hysteria. Our banking sector remains a small, conservative and tightly regulated industry operating in a largely closed currency system.

The following factors suggest current banking industry profits are not high:

  • Slow credit growth: Private sector credit extension expressed as a percentage of gross domestic product is flat on a decade ago and well below its previous high (see graph below). Bank clients are less indebted now, on average, than they were 10 years ago.
  • Muted asset price growth: Capetonians might find this hard to believe, but South African house prices, on average, have not kept up with inflation for 12 years.
  • Conservative provisioning: Post-global financial crisis and post-African Bank – South African banks are cautious. Portfolio provisions are at their highest levels in more than a decade. Provisioning entails sacrificing today’s profits to buffer future profits against potentially adverse developments.
  • Increased regulation: Globally and locally, banks are more heavily regulated now. As a consequence, their assets are supported by higher levels of equity and lower levels of debt, and the riskiness of both their assets and liabilities is reduced.
  • Long-term upside to financial penetration: Sixty-five percent of transactions in South Africa are still done in cash. Excluding South African Social Security Agency cardholders, 58% of South African adults are banked. Only 14% of South Africans borrow from banking institutions. Credit card penetration is estimated to be about 17%; mortgage penetration a mere 5%. 

BGA in the South African context

BGA’s earnings growth has lagged its competitors by a few percentage points every year over the past five years. With hindsight, the bank made a few strategic errors: credit was tightened too aggressively after the global financial crisis, and the product offering became too expensive and lagged its peers in terms of digital functionality. Clients who wanted personal and home loans simply moved their accounts elsewhere.

BGA’s challenge now is to stem the tide and reignite growth in its top line. The bank has a big market share in critical areas but is losing ground to competitors.

Tough times can have a silver lining if they give us the opportunity to buy assets at bargain prices. This might classify as one such opportunity: our recent investment in BGA was at a multiple of 7.5 times its most recent earnings and a dividend yield of 7.8%. It is not every day that one sees dividend yields higher than price/earnings ratios on the JSE, as shown in the graph below.

Absa’s p/e ratio has been lower than its dividend yield on only three occasions in the history we have for the bank (or for its predecessor, United Bank, given that Absa was only established in 1991) – 1988, 1994 and 2008. All those times were characterised by massive uncertainty and investor distress. And in all cases investors would have done well over the subsequent three to four years, as reflected in the following graph.

BGA’s p/e ratio is now at a 60% discount to the average company listed in South Africa, a level only seen twice before, in 1994 and 2008. Similarly, its dividend yield is 1.7 times the dividend yield of the average company, matched only in 1994 and 2008. There is indeed some evidence of matters slowly improving:

  • Better pricing: From being the most expensive six years ago, Absa’s entry-level account is now among the cheapest in South Africa, according to some surveys.
  • Improved transactional banking: This includes first-to-market innovations like “ChatBanking” (transacting via social media) and the world’s first trade finance transaction using blockchain technology.
  • Happier clients: Its net promoter score has improved for four consecutive years. Customer satisfaction surveys are showing improvements.
  • Happier staff: Employee engagement scores are rising.

It takes a long time to turn a big ship around. The market doesn’t believe in BGA’s recovery and expectations are low. As a long-term investor, this negative sentiment is in our favour.

Attend the summit

Allan Gray has partnered with nine local and international investment firms in a new one-day event, aimed at helping investors protect and grow their wealth. The Allan Gray Investment Summit will take place on August 2017 at the Sandton Convention Centre, Johannesburg. For more information and to book tickets, visit www.investmentsummit.co.za.

Patient capital ‘on the sideline’

In the absence of a crystal ball, it is impossible to accurately predict market movements or to foresee a sudden opportunity in shares we like. But we know that, from time to time, we need to be prepared for the unexpected. Three things enable us to react to opportunities with conviction:

  • Thorough and up-to-date research: We research all the companies in our investment universe, whether our clients own them or not.
  • Access to liquidity: Across our equity, balanced and stable mandates, we keep a percentage of the funds in cash to participate in unforeseen events. In a rising stock market, this causes a slight drag on performance but the option of deploying the cash profitably outweighs the cost.
  • Benchmark agnosticism: If we like a company, we will invest with confidence irrespective of the size of the company, our peer group holdings or weight in the benchmark.

These factors will continue to allow us to react to opportunities that we hope will contribute to future outperformance.

This article was paid for by Allan Gray.

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