Standard bucks the trend

Lower business confidence is discouraging companies from borrowing money to spend on expansion

Despite offering returns in excess of their cost of capital, banks which have released their interim results thus far have not seen their share prices recover to pre-downgrade levels.

Bank shares gained after reporting slower growth in headline earnings for the six months to June, only to wilt shortly afterwards.

A notable exception was Standard Bank, whose shares reached their highest point this year just before the release of its results last week.

“Standard Bank has probably produced the best set of results thus far, with a strong performance across its business,” says Bradley Preston, chief investment officer at Mergence Investment Managers. “A number of headwinds that have challenged the group for a few years, namely their London operation ICBCS and their high IT cost growth, seem to be coming to an end. This was combined with strong growth in constant currency from their rest-of-africa operations and good cost control.”

Nedbank was worst hit, plunging 16.6% to R225.20 between its March peak and Monday this week. Barclays Africa declined 6.2% in this period. There were hopes of a recovery after both beat consensus earnings estimates, but the shares remain far below their March levels.

“Both Barclays Africa’s and Nedbank’s share prices have lagged behind those of Firstrand and Standard Bank,” says Adrian Cloete, portfolio manager at PSG Wealth. “Firstrand hasn’t released results yet, but Standard Bank did report the highest headline earnings per share growth of the three banks that reported their first half to date.”

Standard Bank grew earnings 12% to R12.1bn in the first half, against 5% at Barclays Africa — or 7% on a normalised basis that takes into account the effects of its separation from British parent Barclays — and a decline of 2.9% at Nedbank. Excluding pan-african associate Ecobank Transnational Incorporated (ETI), Nedbank’s earnings rose 6.7%.

Cloete says both banks are looking undervalued. Barclays Africa is trading at a historical p:e of 8.2 times, while offering an attractive dividend yield of 7%. At Nedbank, the multiple is 9.7, with a dividend yield of 5.5%. The average p:e for the banks’ index is 11.3 times.

Bloomberg estimates place these banks’ cost of capital at 9.2% and 8.4% respectively.

Barclays Africa reported the highest return on equity at 16.8% for the half year — doubling shareholder value. Nedbank’s return was the second-highest at 15.1%, 18.9% if you exclude the losses from ETI — much more than double the cost of capital.

Based purely on returns, Nedbank appears to be the best share to hold — provided it can rein in the governance crisis gripping its 21%-held pan-african associate.

So what is weighing on bank shares? “Growing revenue is very tough in the current economy,” says Cloete “The banks are facing headwinds from slower corporate and investment banking advances growth, as lower business confidence is discouraging companies from borrowing money to spend on expansion.”

At Nedbank’s corporate and investment bank, growth in headline earnings was pressured by a slowdown in corporate and government capital spending. It kept a lid on bad debts, though, bringing the group’s overall credit losses down to 0.47% of gross loans and advances.

Group CFO Raisibe Morathi says the corporate and investment bank had reversed some of the provisions it raised last year in the wake of the commodities rout, after prices improved this year.

“The credit loss ratios in the corporate and investment bank businesses have improved as most vulnerable companies’ balance sheets have been successfully restructured through corporate actions like rights offers,” says Cloete. “As the banks have previously been providing very conservatively against these vulnerable companies, some of these provisions could be reversed [after] the successful restructurings.”

For now, Nedbank is watching the retail sector and state-owned enterprises, which are susceptible to the economic slowdown and further potential downgrades.

Morathi also says the retail banking division expects a slow increase in impairment provisions from the “current low levels” as its motor vehicle and card customers begin to default.

Cloete says retail and business banking advances are under pressure, as consumers prefer to reduce debt. Fees earned from transactions (also known as noninterest revenue) were contracting in line with the economy.

“Revenue from operations in the rest of

Africa is being translated from weak local currencies into a stronger rand exchange rate,” says Cloete.

The currency’s strength cannot be underestimated. Barclays Africa financial director Jason Quinn said at its July results presentation the rand was relatively weak during the first half of last year, when the bank’s operations outside SA delivered a 15% increase in revenue and a 26% increase in headline earnings when translated into rand.

This time around, revenue from the region plunged 16% and earnings 31% due to the stronger rand.

At Standard Bank, its “Africa Regions” segment delivered a 46% increase in headline earnings on a constant currency basis, but this was worked down to just 16% when translated into rand.