As Covid-19 cuts short an unbroken 20year run, is it time to start rating Capitec like any other boring bank stock? R1,168.13 47.1%
ý Capitec started 2020 safely ensconced as one of the rock star counters on the JSE.
Its share price was hovering near a record high of around R1,500; it had just added business banking to its repertoire with the acquisition of Mercantile Bank; and it was by far SA’S biggest bank by client numbers.
Fast-forward to July and you’d be forgiven for wondering if the Capitec growth story has run its course.
Besides Naspers, Capitec has been one of the best investments in SA corporate history — by January 1, there had been a gain of more than 80,000% since listing in 2002.
But Capitec’s share price has almost halved since the start of the year, trading at R777.81 at the time of writing, thanks to the Covid-19 pandemic’s devastating impact on the economy.
Just how devastating was revealed last week, when Capitec warned that earnings were expected to plunge more than 70% in the first half. To say the market was disappointed would be an understatement.
The question now is whether it is time to start rating Capitec more like other bank stocks. Capitec is more expensive than the other bank shares. It trades on a forward p:e of 19.2, whereas rival Firstrand is priced at a p:e of about 9.9.
But, says Avior banking analyst Harry Botha: “I don’t think it’s as simple as saying the market is rerating Capitec and it’s going to trade more in line with the big four banks from here on in.
“A lot of [the expected earnings drop] has to do with Capitec being very proactive by raising
Target price: Potential upside:
* Based on analysts’ consensus forecast
bad debt provisions aggressively to deal with the impact of Covid-19. By taking the pain upfront and provisioning for credit impairments now, Capitec won’t have to deal with future impairments further down the line.”
Capitec’s total credit impairment provisions had increased by a huge R3.3bn as at May 31 compared to figures for the end of February.
Most of that increase — R3.195bn — is in Capitec’s retail banking unit, which is inherently more exposed to cyclical economic fluctuations due to its large unsecured lending book.
“The unsecured business is obviously going to be very badly [affected] in this environment, but it is made worse by the very aggressive provisioning policy and payment holidays introduced by Capitec,” says Patrice Rassou, chief investment officer of Ashburton Investments. “The next year or two is going to be quite tough economically and that will affect Capitec.”
Rassou says the timing of Capitec’s move into business banking is also rather unfortunate given the impact of Covid-19 on small to medium-sized enterprises (SMES).
Capitec made the final payment of the total R3.56bn it paid for Mercantile Bank in November, meaning it would still have been bedding down the operation when SA’S first Covid-19 case was reported in March.
In fact, with SMES facing a grim future due to the constraints placed on business activity, the timing could hardly have been worse for Capitec’s business banking ambitions.
“It calls into question the synergies and growth that Capitec can extract from its business banking unit,” says Rassou.
Nevertheless, the credit impairment provision Capitec made for business banking in the July 3 trading statement was R406m, just R91m more than the R315m provision it had made based on its February 29 2020 numbers.
Botha acknowledges this figure may be on the optimistic side — especially when compared to the large impairment provision for its retail business — but says it’s likely due to fewer than expected SMES seeking government assistance and the fact that business banking still comprises a relatively small part of Capitec’s earnings.
With its large unsecured lending book and greater exposure to clients from lower economic echelons, Capitec clearly sees a greater risk of delinquencies from its retail book.
Another issue Capitec faces is that its retail arm’s reinsurance agreements (which cover client insurance claims for retrenchment, death or disability) expired on April 30.
That leaves Capitec liable for any claims with an event date of
May 1 onwards.
CEO Gerrie Fourie first disclosed this at Capitec’s AGM on
May 29, saying the group was in discussions with “four or five” reinsurers to transfer some of that risk away from its own balance sheet.
Thus far there is no official word on how these talks are progressing, but while Capitec would no doubt want to transition to multiyear reinsurance contracts, it may be a challenge. With so many people facing layoffs it is unlikely that reinsurers will be falling over themselves to provide retrenchment cover in the current economic climate.
So what is the outlook for Capitec for investors?
Botha believes Capitec will continue to trade at a premium to the big four banks for some time, saying it still has a lot of supporting factors.
“Management are very highly rated and at their last AGM they indicated that around 60% of their customers are regarded as providers of essential services, which obviously gives some insulation if there are further lockdowns,” he says.
“The really important question is whether they have enough capital and at this stage it would appear to be the case. If they have to raise further capital then obviously the share price would rerate fairly aggressively.”
During Fourie’s presentation at the AGM he revealed that the bank’s capital adequacy ratio is a robust 31%.
Standard Bank’s, by way of comparison, is 14%.
Yet with Capitec’s share price still hovering near the R800 mark, Rassou says he sees better value elsewhere on a relative basis.
“The big commercial banks are all trading at a bigger discount to NAV,” he says. “At this stage of the economic cycle more defensive banking counters like Firstrand or Standard Bank might be preferable.”
Tumi Loate, an investment analyst at 36One Asset Management, agrees. “Given that its focus on retail banking and unsecured lending provides less diversification than the traditional SA banks, we think the valuation remains stretched and expect some form of derating over time,” she says.
“Our view is that the market price is not warranted given the lacklustre environment.”
The next year or two is going to be quite tough economically and that will affect Capitec
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