By Sithembile Bopela
The local banks have performed well over the last year as higher interest rates have served to prop up net interest margins (NIMs) and transaction activity has been resilient despite the subdued global macro environment and a myriad of other challenges that have hampered local growth. Credit loss ratios (CLRs) have ticked up but did not rise to concerning levels. Bank stock prices have performed well over the last year but despite a decent run from mid-April, the JSE Banks index is still trading below the line on a year-to-date basis.
We think there is scope for a decent performance for the remainder of the year - particularly in the event of a "benign" election outcome. Additionally, we expect the banks to receive decent support from an expected easing in global macroeconomic conditions and signs of local structural reforms taking shape. While lower inflation will eventually translate into lower interest rates that will compress net interest margins, higher growth in non-interest revenue (higher transaction activity and loan demand) and a better credit experience (and consequent reserve releases) may outweigh this impact.
In general, banks remain well capitalised, with high provisioning levels which will likely limit the risk of a severe deterioration in credit losses to pandemic or global financial crisis (GFC) levels. On top of near-term support drivers, we view long-term fundamentals as favourable and valuations as attractive at current levels, with the exception of Capitec.
Standard Bank (SBK)
Standard Bank offers banking and financial services to individuals, businesses, institutions, and corporations. Standard Bank's major competitive advantage is its mature exposure to higher growth African regions ex-South Africa.
Over the last few years, the group has seen a meaningful improvement in profitability. Its ROE expanded from 16% in FY22 to 19% in FY23. This was underpinned by improved cost containment following an extended period of elevated IT infrastructure spending as well as strong top-line growth driving a positive jaws experience. This was overlayed by positive contributions from the group's strategic expansion into broader Africa (ex-SA), which now accounts for ~42% of revenue.
The change in geographical contribution is a key feature of the bank as many of these markets are still under-serviced and have low banking penetration rates.
Against a backdrop of persistent macroeconomic uncertainty, net interest income (NII) growth over FY24 is expected to slow down significantly, while jaws is expected to be flat, per management. Nevertheless, the outlook over the long-term remains positive, with operations across the rest of Africa set to make an even bigger contribution to profitability going forward.
The share is trading on a forward price-to-earnings (PE) of ~6.6 times and a price-to-book (P/B) of ~1.3 times, which is well below its average rating over time. The bank is also offering a healthy dividend yield of ~8.6%.
FirstRand (FSR)
FirstRand is an integrated financial services business that provides banking and insurance products and services to retail, commercial, corporate, and public sector customers. The group operates in South Africa, certain markets in sub-Saharan Africa, the United Kingdom (UK), and India.
The group maintains a premium valuation relative to its peers, on the back of its relatively high asset quality and a history of outperformance. At 20.6% and 1.8%, the group has leading ROE and ROAs respectively, relative to the big four and Investec. The bank has a history of steady growth that has also supported its structurally higher return metrics.
Investors have been worried about FirstRand's UK business - this includes concerns over lower return metrics in Aldermore and its exposure to the UK vehicle finance market - currently the subject of an industry-wide review by authorities. There may be a near-term impact of the latter in the form of a provision to be taken at the full-year mark.
Nevertheless, it maintains a dominant force in the sector and holds significant market share across different client categories. Additionally, FirstRand is hedged against declining interest rates, which could give it a leg up relative to peers once interest rates start coming down.
Prospects for the long term are encouraging, and the valuation remains attractive. FirstRand is trading on a forward PE of ~9 times, well below its long-term average (~10.5 times), and a P/B of ~2 times, which is also much cheaper compared to where it has traded in the past.
Nedbank (NED)
Nedbank is one of the largest financial services groups in Africa, offering wholesale and retail banking services as well as insurance, asset management and wealth management solutions. The bank primarily operates in South Africa, with markets in broader Africa through subsidiaries and banks in Lesotho, Malawi, Mozambique, Namibia, Eswatini and Zimbabwe, as well as representative offices in Angola and Kenya.
Nedbank's corporate-and-investment banking makes up a significant portion of earnings (~50%), which places a drag on performance in an environment where corporates are reluctant to invest. This makes the group more geared to a turn in business confidence and market conditions in general. The group also has very high exposure to the property sector, with ~36% commercial property market share (as a % of total core loans). The sector has been adversely impacted by pandemic-related challenges; however, Nedbank maintains exposure to a portfolio of high-quality assets with adequate collateral. This significantly reduces the risk of potential losses, mitigating a significant deterioration in credit losses on the real estate book.
Additionally, the bank's strong renewable energy and self-power generation pipeline, in the context of energy capacity constraints locally and the clean-energy transition, could prove very positive. Nedbank expects a good pipeline of deals to close during the year, with estimated book growth of R18 billion in 2024.
The bank has seen a gradual recovery in its ROE, coupled with an improved ROA (FY23: 1.21% vs FY22: 1.14%), underpinned by an improvement in capital efficiency and profitability over time. The group's IT modernisation project is near completion (~95% as at the full year), with leadership aiming for finalisation by the end of 2024. This has yielded structural cost optimisation benefits, with savings of R2.2 billion to FY23, which should continue to support a reduction in the group's cost-to-income ratio and return metrics.
Nedbank is trading on an attractive P/B of 0.9 times and an attractive dividend yield of 6.5%.
Absa Bank (ABG)
Absa is among South Africa's largest financial services groups, and offers a complete range of banking, assurance and wealth management products and services. The group holds a presence in 12 countries across the African continent.
In terms of profitability metrics and share price returns, Absa has recently lagged peers, in part due to its primarily internal focus to better align and reconfigure the business strategy through several executive changes and expanded commercial cluster divisions as well as a brand revamp, post its lengthy Barclays separation.
However, in terms of recent financial performance, the bank's diversification across geography and business lines has provided some resilience, with strength from the Africa regions (FY23: +124% to R6.2 billion) providing some offset to lower SA earnings (-18% to R14.7 billion). Exposure to Africa remains a key growth vector as many of the markets it operates in still have low banking penetration.
The bank maintains a strong balance sheet, and is well capitalised with a healthy liquidity position, offering support for continued income payments to shareholders. As such, the dividend yield is exceptionally attractive relative to its peers.
In terms of the outlook, elevated credit impairments, plus slower revenue and pre-provision profit growth in 1H24, are expected to dampen growth off a relatively high base. However, the group expects higher revenue growth in 2H24 to support stronger pre-provision profit growth that, combined with a lower credit loss ratio, should result in better earnings growth versus a less demanding base.
The valuation looks attractive, on a P/B of 0.9 times and a forward dividend yield of 10.3%.
Investec (INL/INP)
Investec is an international specialist bank and wealth manager that provides a distinctive range of financial products and services to a niche client base in its core geographies being the UK and SA.
Due to its exposure to UK banking, the company trades at a substantial discount to its peers even when accounting for the UK business. While the group's geographical spread introduces a higher level of sensitivity to currency movements and increases forecast risk, it does, however, add a rand hedge element to the name. Also, the group is now more diversified and less reliant on poor quality market-geared earnings than in the past.
The company is well positioned, with its established platforms in the UK and SA to support continued earnings growth. Its Wealth businesses is doing exceptionally well, and the recently announced tie-up of its UK division with Rathbones is promising and will provide scale to the business.
Operationally, lending rates remain robust in the UK and SA, highlighting steady loan demand and in turn driving steady book growth and a robust underlying performance.
The group's credit cost experience remains decent, although the credit loss guidance for FY24 (midpoint of the TTC range: 30bps) would signal a notable deterioration from the previous period (FY23: 23bps) - with lower credit impairments in SA offset by more elevated levels in the UK. Across the portfolio, the bank noted idiosyncratic client stresses, amid a challenging macroeconomic and elevated interest rate environment. However, asset quality remains solid, with no evidence of trend deterioration in the overall credit quality of the lending books.
Investec is trading on a price to book of 0.9 times, which seems elevated relative to its history but in the context of a recent lift in medium-term guidance for its returns metrics, and strong book, still seems to offer value.
Capitec (CPI)
Capitec is SA's fastest growing retail bank, which provides accessible and affordable banking facilities to clients via its innovative use of technology in a wat that is convenient and personalised. The bank's target market has expanded over the years, with middle- and high-income individuals also wanting to take advantage of its competitive fees and deposit rates. Capitec has a flexible banking platform, making expansion into other banking areas relatively easy.
The growth of the group's value-added service (VAS) has been a key feature, underpinned by higher transaction volumes and client growth, and likely to support long-term success. With an aggregate of ~22 million customers (FY24: +10% y/y), Capitec serves more than a third of the SA population. However, only 35% of this base, or 7.8 million (FY24: +13% y/y), are main banked clients. Much of the bank's growth hinges on its ability to successfully monetise its base of existing and new clients and using value added services to narrow the significant disparity between its core and total active base.
The bank's operating expenses have remained elevated, particularly due to the group's increased investment into IT and staff to support its growth momentum. Still, Capitec maintains a history of positive jaws, which is expected to improve further over the medium term. Critically, a slowdown in spending on business investment and product expansion as the business continues to scale, could yield higher operating leverage and in turn enhance earnings growth.
Due to its higher growth prospects, Capitec (6 times P/B) continues to trade at a significant premium to its peers (2 times P/B average). This could see the share come under significant pressure should there be a material slowdown in growth.
