What Can We Learn From the Banks? 📈

The Finance Ghost shares his curiosity about Banks. With the Budget Speech now behind us and a lot to be worried about in terms of South Africa’s economic trajectory, it’s time to look at the banks and determine whether they are worthwhile investments in South Africa. Can they buck the trend of the economy and deliver desirable returns?

In figuring out the road ahead, it helps to look at the road already travelled. The performance over 10 years tells us a great deal about where we’ve come from.

Nedbank is trading at a price that we also saw back in 2014. Ouch. If we go back exactly 10 years to February 2014, then Nedbank is up just 10% in ten years – or less than 1% a year once we factor in compounding. There’s been an enormous amount of volatility between then and now of course, but you get the idea.

It would be wrong not to highlight the dividend yield, which has averaged 5.7% over the past decade. Still, even on a total return basis, the reality is that Nedbank has barely returned more than an investor would’ve gotten in a money market account over the period under review. One is practically risk-free and the other certainly isn’t, so the risk-adjusted equity return has been highly disappointing for investors.

At Absa, the share price has grown 25% over this period, which is a CAGR of 2.3%. That’s better than Nedbank but certainly not by much. The average dividend yield of 6.3% is also higher than Nedbank, so the total return is in favour of Absa. Still, it’s not an exciting risk-adjusted return.

Over the same time period, Standard Bank has grown the share price by around 75%. That’s a compound annual growth rate (CAGR) of 5.7%, which is higher than the abovementioned banks but certainly isn’t a rocketship. This is despite Standard Bank doing a solid job of diversifying into Africa. The average dividend yield over the period of 5% does help to take the total return into double digits, which is starting to look more like where you want to be. We won’t depress ourselves by working it out in dollars, otherwise we may as well just give up now.

FirstRand has done a lot better, with the share price more than doubling over 10 years. This works out to a CAGR of 7.7%, with FirstRand having done a solid job of building a broader financial services business than some competitors. The dividend yield has averaged 4.5%, taking the total return above the levels achieved by Standard Bank.

In all these cases, the banks have struggled with the macro issues plaguing South Africa. They’ve also had to fight off an exciting new competitor over this period, which brings us neatly to Capitec.

Over the same period as the rather asthmatic returns delivered by the other banks, Capitec is an eleven bagger. Yes, this company has grown its share price to a level more than 11x higher in ten years. This is a CAGR of over 27%. The dividend barely seems to matter when you’re dealing with capital growth like that, but it comes in at an average yield of 1.7% over the past decade, just to sweeten the deal even further. Even when you factor in the depreciation against the dollar, Capitec has delivered solid returns by global standards.

But what can we learn from these performances?
Banks cannot easily escape the tide they are swimming in.

The largest banks struggle to deliver a performance that differs materially from the flavour of the macroeconomic environment in which they operate.

When a country is under pressure, banks are also under pressure as demand for credit diminishes and the risk on the book needs to increase in order for the bank to simply operate its core business. This doesn’t do good things for the quality of net interest income (NII) as credit loss ratios move against the bank. Opportunities for advisory and other services are thin on the ground, so it’s difficult to drive non-interest revenue (NIR) or improvements in the key driver of value for a bank: return on equity (ROE).

In a growing, supportive environment, the banks attract more deposits and can make higher quality loans, so NII has a good story to tell. A growing economy is an innovative economy, which supports the NIR side of the business. The net result is ongoing improvement in ROE and thus the price-to-book multiple (the key valuation metric) at which the bank trades.

Long story short: the macroeconomic conditions have a flywheel effect that is difficult to avoid. But they can win market share (and lose it)

You might have caught yourself wondering about Capitec while reading that last section. After all, how did it deliver an eleven-bagger result over the same time period that saw the others bumble along?

If the size of the pie isn’t growing, then the only way to grow is to get a bigger slice of the pie. This can only happen at the expense of the other players in the market. The significant difference between the performance of Capitec and the peer group is more related than you think, as Capitec’s gain was its competitors’ pain.

Nobody would’ve looked at South Africa’s macro story over the past decade and predicted these kinds of returns from a bank. Capitec achieved this outcome by identifying a gap in the market and executing on it to a high standard. By adopting a no-frills approach to traditional banking services, Capitec won market share and became an excellent case study of how to disrupt an industry.

It says a lot about Capitec that it’s the only bank to achieve good returns when expressed in dollars. It says even more about South Africa that only one bank managed that feat. That was then and this is now.

Where are we headed from here?
As a country, we have major infrastructure challenges that don’t seem to be going away. This has been an opportunity for the banks in some respects, such as demand for credit for solar projects. Overall though, the negative impact on GDP growth has also hurt the story for our banks.

At individual bank level, there’s a lot to think about. The likes of Nedbank and Absa seem to show promise from time to time, but they never quite manage to escape the trap of being the underperformers in the peer group. FirstRand is seen as a quality operation but the traded multiple reflects it, which is why the performance has been limited in recent years.

As for Standard Bank, the African exposure has worked out well recently. With a share price up 14% in the past year, the market has appreciated the growth story beyond South Africa’s borders. Once more, this says as much about South Africa as it does about Standard Bank. Of the traditional local banks, this would be my pick in the sector.

But what of Capitec, the superstar? The share price is up 17% over 12 months but you needed a strong stomach for this one, with a 52-week low of R1,328 and a 52-week high of R2,120. This is a choppy performance that shows some nervousness around the valuation, not just in terms of Capitec’s top-line growth but also with regard to the expenses coming through the system.

On a risk-adjusted basis, I would pick Standard Bank in this sector. I would be open to opportunities that the volatility in the Capitec price can present. As for the others, it feels like there are more appealing places to allocate my capital.

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