Bank shares: buy now, or wait?
Better economic conditions and commodity prices are boosting banks’ noninterest income, Jaco Visser
The JSE banks index hit a record high on April 1 even as some of the country’s lenders trade at attractive valuations and equally attractive dividend yields.
The gauge gained 57% over the preceding 12 months and more than 143% since its multiyear low on May 15
2020. This prompts the question of whether SA banks pose value to investors.
With a combined market cap of R1.33-trillion, the eight constituents of the banks index form a chunky part of the country’s listed companies. Dividend yields vary from 1.6% for Capitec to 5.4% for Nedbank. On the valuation side, the p:e multiples range from about
31.1 for Capitec to 7.9 for Nedbank.
A word of caution, though: most analysts opt to use price-to-book (p:b) ratios to value banks. This gauge compares a business’s market value (market capitalisation) to its NAV. Using this measure, Nedbank is the cheapest banking stock, on a p:b of
1.08, while Capitec is the most expensive, with a p:b of 7.35. Maybe apart from Capitec, these valuations are not on the expensive side.
After coming through a pandemic that devastated lives and economies alike,
SA’s banks recovered quickly. This could be ascribed to the country’s economy being “more resilient than many people thought”, Capitec CEO Gerrie Fourie tells IM. Fourie is also upbeat about SMEs, which stood firm during the Covid onslaught.
This resilience can be ascribed to mineral prices holding steady at elevated levels over the past two years, acting as a lifebuoy to the domestic economy. Slowly evolving government reforms of the economy, especially in energy generation, bandwidth spectrum and, recently, railways, may also boost investor confidence, and subsequently benefit banks.
Daniel Masvosvere, senior equity analyst at Ashburton Investments, says the money manager “remains constructive [about] the [banking] sector”. This is despite the landscape of banks, namely the traditional big four lenders plus Capitec, now facing new challengers, such as low-cost TymeBank and Bank Zero. These should not be overestimated, though.
“The short answer regarding the challenger, or new, banks is that their impact on the big four plus Capitec right now is marginal at best,” says Masvosvere. “This is not to say it can’t change in time, but the current state of play is [that there is] no material, discernible adverse impact.”
Let’s first consider the battle for retail market share. This refers to individuals who have current, savings and loan accounts with banks. Some people also opt for insurance, including credit life, life and funeral cover. Retail banking is an important profit-spinner for the banks and has been highlighted by the recent appointment of Arrie Rautenbach as CEO of Absa. Rautenbach previously headed Absa’s retail and business banking division and is credited with turning the division around and making it the largest contributor to the bank’s 2022 profit.
Capitec, which was traditionally viewed as a bank that targeted lower-income consumers, is increasingly taking more affluent market share away from the big four: Standard Bank, FNB (owned by FirstRand), Absa and Nedbank. Capitec’s push into what some may call a mature SA market continues even as Absa announced early in April that it will roll out mobile banking units to try to recapture market share among lower-income earners.
Lenders that embraced a shift to digital and workflows early on, such as Capitec and FNB, stand to win the most. Brick-and-mortar servicing of customers (ironically, only Capitec is increasing its branch footprint) weighs heavily on the big four. Branch floor space has been declining among the four for a couple of years and was accelerated at the height of Covid as more
consumers, especially in the lower-middle-income to more affluent group, embraced digital banking.
Retail banking fees contribute to noninterest income, as do business and corporate banking and trading fees.
Standard Bank, Africa’s largest lender by assets, reported noninterest revenue, excluding investment management and life insurance activities, of R51.1bn, 45% of all its revenue from banking activities, in 2021. Stripping out investment and insurance income at
FirstRand, the lender with the largest market capitalisation earned noninterest income of R21.5bn for the six months to December 31. This equates to 42% of income from banking activities. Absa realised R22.1bn in noninterest income, 40% of revenue in 2021. Nedbank bagged R22.2bn in noninterest revenue, 41% of revenue.
On the other hand, Capitec generated net transaction income of R10.5bn, or 45% of its total net income before expenses, for the 12 months to February 28, according to its financial statements.
Chris Steward, sector head of financials at Ninety One, advises caution regarding banks’ fee income in future. “Fee income will grow with nominal GDP [growth] as long as we can foresee,” he says. However, this line item in banks’ income statement will be under pressure as lenders target more customers, and will likely result in a situation where they’ll need to drive transaction volume growth with transaction prices under pressure, Steward says.
Nevertheless, more benevolent economic conditions, driven by slowgrinding government reform and strong commodity prices, should continue to boost banks’ noninterest income.
“Consider the positive noninterest revenue growth, linked to the pick-up in economic activity, as we come out of the pandemic,” says Masvosvere.
In addition to improved noninterest revenue, the higher inflation environment may also stand banks in good stead. Steward says the Reserve Bank will increase its repo rate by 100 basis points this year, which will add R3bn-R3.5bn to banks’ earnings.
“There is a positive outlook for bank margins as the Reserve Bank hikes rates, which coincides with a benign outlook for credit losses,” says Masvosvere. “Retail credit growth has held up well, but a look at the aggregate SA consumer balance sheet shows there is still a healthy runway here, while corporate credit is yet to get going,” he says.
Steward gives a word of warning regarding domestic banks’ offshore earnings amid a stronger rand. The SA currency strengthened from R15.85/$ at the beginning of the year to R14.59/$ at the time of writing. According to Steward’s calculations, Standard Bank, which operates in 20 African countries, earns about 30% of its revenue outside SA, Absa 20% and FirstRand 10%. “The rand is being a drag on these earnings,” Steward says, and cautions that these banks “will be battling currency headwinds” in their offshore earnings.
But should you buy? Since the beginning of the year, FirstRand’s shares have returned 17%, Standard Bank’s 19%, Capitec’s 6.5%, Absa’s 12.6% and Nedbank’s 26.8%.
Steward says banks’ “valuations are not stretched” and that historically they have been trading at these levels. He expects earnings growth of 10%-20% over the next year among the banks. In terms of their p:b valuations, he says banks are trading at close to their fair value, with no significant upside.
Interestingly, Steward says there is scope for banks to increase their payout ratios the percentage of headline earnings returned to shareholders as dividends. “Payout is now almost half of earnings,” he says. This varies between the banks.
Masvosvere, on the other hand, says current valuations of banking stocks do not fully reflect the upside for credit growth. “Even without this, the banks are already sitting on significant capital in excess of both internal and regulatory minimums. Some of this capital will definitely be returning to shareholders via, in some cases, higher dividend payout ratios and potentially special dividends. In light of these tailwinds, we continue to hold bank stocks.”
Standard Bank, earns about 30% of its revenue outside SA, Absa 20% and FirstRand 10%