Banking shares: shelter from the storm
Banks are the most stable part of the SA Inc market and enjoyed a rally in October and November
While there have been some disturbing trading updates from retailers, the major banking groups have kept silent.
Neelash Hansjee, manager of the Old Mutual Financial Services Fund, says bank earnings will cluster at growth of about 3%-7% in the year to December. And Capitec, with a February year-end, is expected to repeat its 20% growth in the first half.
A high part of Capitec’s income still comes from personal loans. The bank is more affected than the rest of the sector by International Financial Reporting Standards (IFRS) 9, which measures nonperforming loans more strictly than before. But IFRS 9 could also shave one or two percentage points off any of the universal banks’ earnings growth.
Hansjee says that Capitec has several levers of growth other than unsecured loans.
The sales numbers reported from its funeral policy joint venture with Sanlam look impressive and there is plenty of runway for its Global One credit card. And as the buyer of Mercantile it has avoided the long and tedious process of building a greenfields business bank.
Banks are the most stable part of the SA Inc market. And at the tail end of a poor year for rand hedges such as British American Tobacco and Naspers, banks enjoyed a rally in October and November. Louis Chetty, financials analyst at Stanlib, argues that many rand hedge share prices don’t yet reflect the global macro-uncertainties, or even the well-flagged risks of a messy Brexit outcome.
Chris Steward, head of financial research at Investec, argues that banks have had modest asset growth, well-controlled impairments and stable margins. "Banks have a very different business model from the cash retailers, as they are earning money from loans which might have been on the books for 10-20 years."
Steward says bank share prices are ahead of the JSE over the past four months by about 12%, but he says they are not pricey, as they are genuinely defensive. On a 12-month view the banks’ performance has not been spectacular: industry darling FirstRand is down by 1%. But that’s excellent compared with, say, Woolworths, which is down 22%, or Shoprite, down 25%.
Yet these shares still trade on higher p:e ratios than the banks.
The one that could be a value trap is Absa, with an attractive 6% yield. Chetty says 2019 will be the crunch year for separation from Barclays, in particularly the execution of a full separation of IT and the introduction of the Absa brand into the African markets, where South Africans might be even more unpopular than the British. If these tasks are not achieved by mid-2020, Absa will have to start paying penalty fees to Barclays. Chetty says that at least Absa has strengthened its bench with the appointment of the experienced Charles Russon as head of the corporate and investment bank and Arrie Rautenbach as head of the retail bank.
Either will be a strong candidate to become permanent CEO of the group when current CEO Maria Ramos retires at the end of February. Ramos was not a career banker and had an indifferent track record at the bank, but many shareholders hoped she would at least see through the unwinding from Barclays to the end.
Steward says Rautenbach gave a glitzy showbiz presentation on the new-look retail bank at the end of 2018, though he still has to deliver.
But the BA 900 monthly banking statistics show that Absa is regaining market share, particularly in home loans, where for some time it allowed Standard Bank to eat its lunch. One piece of good news is that Absa has already written off so much of its Edcon credit book that there isn’t much more left to provide.
Chetty says Standard Bank has a more valuable African franchise than Absa. It accounts for about a third of Standard Bank’s earnings but is vulnerable to the oil price, as Nigeria and Angola are key markets, and the African retail market is still only a nominal contributor.
But the remnants of Standard Bank’s nonAfrican businesses will bite. The Argentine bank — which made a larger contribution than Africa Retail in the first half — will look terrible after the collapse of the local currency, and the London bank still has to regain its footing after merging with group parent ICBC. But the longed-for rebuilding of the core banking system is now over, and the bank can start to look outward again. It will do well to repeat the 10% earnings growth from the first half, however.
FirstRand is working off a high base, and could be subject to guerrilla attacks from Discovery, which has taken over a lucrative 300,000-member credit card book. Steward says FirstRand’s first half to December should be able to match the 7% growth in the 2018 year.
Steward says: "I am sure Discovery will build up a credible banking franchise over the next few years, but any short-term impact on the universal banks’ earnings has been overblown."
The same applies to other interlopers such as TymeBank, Bank Zero, Postbank and even African Bank.
But in the year to June 2019 FirstRand will struggle to pull a rabbit out a hat to match the private equity profit of Servest UK in 2018 or of Kwikot in 2017. The purchase of Aldermore, one of the UK’s challenger banks, further differentiates FirstRand from the pack.
A more aggressive impairment of intangibles, however, could make published group results confusing.
Nedbank’s 27% growth in the first half of the year was driven almost entirely by the recovery of its investment in the West Africa-based Ecobank.
Managed operations growth was just 2%.
It is puzzling that Nedbank was unable to increase earnings for its Wealth business, which incorporates the old Syfrets and BoE businesses as well as a much stronger heritage than the Johhny-come-lately offerings at the other banks.
Nedbank also has a superb range of "best of breed" unit trusts. And the return on equity is falling at the corporate bank as fast as it is growing in the retail bank. Nedbank should be able to improve on the 2% growth, but don’t count on much more than 5%.
Nedbank is on the same dividend yield as Standard Bank, 4.8%, which shows that the market isn’t giving enough for Standard Bank’s superior Africa regions franchise, nor its stronger base in both the retail and the large-cap corporate market.
Nedbank might show new dynamism without the dead hand of Old Mutual, but it needs to prove that.