Serious focus on cost-cutting needed

s the light breaks through the clouds of the pandemic, there are some positive signs in Sasfin’s results. For example, the credit loss ratio for the year to June 2021 was the best it has been in five years, down to 75 basis points (BPS) from a huge 303BPS in 2020, in the heart of the pandemic.

But before investors get too excited, we need to step back and look at Sasfin’s bigger picture. The bank’s primary exposure has been to SA entrepreneurs, focusing on their businesses and personal wealth. That hasn’t been a great strategy in recent years as the economy has floundered and many South Africans in that layer of society have emigrated.

On top of this, management has not won many admirers in the market. There have been some odd capital allocation decisions and many have perceived Sasfin as a family business that is run with the benefit of other people’s money.

Sasfin’s share price is trading at similar levels to what they were during the global financial crisis in 2008. This hasn’t been a wealth creation tool at all for investors, which is ironic, considering the underlying services offered.

Sasfin isn’t a stock to buy and forget.

Interestingly, the share price experienced a less severe drop and recovery in 2020 than many other JSE counters, as Sasfin was already trading at depressed levels heading into the pandemic. From the peak at the start of 2017 to the beginning of 2020, Sasfin fell more than 60%.

In 2021, Sasfin has added

Aabout 14% to the share price. That’s a decent outcome in isolation, but it is well below the performance that we’ve seen from many other value plays on the JSE.

Investors are cautious with Sasfin because the growth record is nothing to write home about. By IM’s calculations, the NAV share has grown at a compound annual growth rate of under 3% over the past five years.

With a dividend payout ratio of between 20% and 40% in that period, Sasfin has retained a significant portion of shareholder funds and has consistently produced disappointing outcomes with that money.

This comes through clearly when looking at return on equity (ROE), which has ranged between 8% and 10% in recent years, other than in 2020, which was obviously a one-off shock from the pandemic. When ROE is running below the cost of capital for investors, the only possible outcome is a share that trades at a discount to book value.

In 2017, Sasfin traded at a premium to book, when ROE was over 13.5%. If the share price is going to close the substantial gap to NAV (now trading at a discount of about 50%), ROE needs to improve by 400BPS from current levels.

Though the credit loss ratio looks a lot better, other elements of the latest financials are cause for concern.

Since June 2020, gross loans and advances grew only 1.24%, so SA entrepreneurs clearly aren’t champing at the bit to borrow money and expand their businesses.

This isn’t just a Sasfin issue, as all the banks have pointed out that the demand for credit has been muted among corporates and SMEs.

While other banks have benefited from strong demand for credit from retail customers, Sasfin doesn’t play in that space with a meaningful product offering. The focus on asset finance, business banking and trade finance needs a tailwind of growth in SMEs.

The other major issue is the cost-to-income ratio, which was nearly 78% in 2021.

The four big banks are typically run at between 55% and 60%, while Capitec manages 40% thanks to a focused business model. Sasfin is the inefficient outlier and the trajectory in this ratio has been one of the drivers of the share price disappointment since 2017.

The ratio has climbed from 69% in 2017 (still high by any standard) to its current level.

If Sasfin were serious about unlocking value, there would be a major focus on cutting costs and buying back undervalued shares in the market. Sasfin recently spent R135m repurchasing its preference shares, which were trading at a significant discount to book value in a market with thin liquidity.

This was funded by internal cash resources, which were boosted by the disposal of the stake in Efficient Group in December 2020 for R146m.

The ordinary shareholders should be next in line. A dividend payout ratio of 20%-40% in recent years isn’t acceptable when ROE is well below where it should be.

Until management gets serious about minority shareholder value creation, Sasfin will keep disappointing. ●

“Though the credit loss ratio looks a lot better, other elements of the latest financials are cause for concern