Bank earnings collapse under economic fallout
I am almost tired of writing about how Capitec’s valuation cannot be justified. Almost.
Trading at a Price / Book value way above its peers, Capitec’s top management continue to shrug off the realities of lockdown. Shareholders are reassured that everything will be ok and that Capitec will still show a profit this year.
Will that be the case? Latest earnings releases from other South African banks suggest that it might not be.
Standard Bank confirmed two weeks ago that Headline Earnings Per Share (HEPS) will be between 30% and 50% lower for the six months ended June 2020.
This is the least comparable result to Capitec’s realities, because Standard Bank has a number of international banking interests. As the most globally diversified option of our local banks, Standard Bank is the only bank I own shares in.
The share price is down nearly 37% for the year (I thankfully bought in March).
FirstRand (holding company of FNB)
FirstRand’s results are skewed by the sale of the Discovery Card business to Discovery as part of its new banking offering. Normalised earnings per share is the most helpful measure in FirstRand’s numbers as it strips out the effect of this sale.
FirstRand expects this earnings measure to fall by 35% to 45% for the year ended June 2020. Importantly, FirstRand’s earnings were up 5% for the first six months of the year, so huge pain has been taken in the lockdown period.
It’s useful to understand that, as with all the banks, impairments and credit loss provisions were the driver of this decrease, as the bank must assess what the likely bad debts will be as a result of mass job losses and economic pressure. This assessment leads in a loss being recognised before there is a genuine default by borrowers. The entire loss would’ve been recognised in the latter part of the year.
It might seem odd that losses are recognised before they occur, but this is to protect shareholders but presenting a balance sheet that takes expectations into account. This is exactly why Price / Book is an appropriate valuation tool for banks, because the book value is reasonable reflection of the true market value of the assets and liabilities.
It’s also important to remember that FNB’s clients are higher LSM families who would in many cases have two sources of income and at least some savings. They are more cushioned than lower income families.
FirstRand also has extensive wealth management interests (locally and abroad) and the best investment bank in the country (RMB), all of which would’ve helped to soften the true impact of lockdown on the purely banking earnings.
The share price is down 40% for the year, slightly worse than Standard Bank.
Absa is the best insight we’ve had thus far into the true state of play in South African banking.
Absa’s normalised headline earnings per share will completely collapse thanks to lockdown. A decrease of 92% to 97% is expected for the six months ended June 2020. This means Absa barely broke even over the period.
Absa gives some insight into impairments, noting that the credit loss ratio (bad debts as a % of total amounts loaned to customers) has blown out to 2.77% from 0.79%. That’s enormous in banking terms.
Absa isn’t about to go bankrupt (none of the banks are), but things are clearly incredibly tough at South African banks.
Absa’s share price is only down 24% for the year, less than its peers because Absa was already trading at a lower relative valuation.
Nedbank took a different approach to disclosing earnings for this period, releasing a voluntary trading update in May accompanied by a forward looking trading statement for the six months ended June 2020.
In that announcement, Nedbank noted that earnings would be at least 20% worse over the period. We shouldn’t read too much into this, as they are only obliged under JSE rules to alert shareholders to an earnings differential of at least 20% vs. the comparative period (up or down). They have done that, so the real story will come out when they release interim results.
There is little doubt that the result will be far worse than a 20% drop in earnings.
Nedbank’s share price is down 31% this year.
I’ve written about Capitec before and expressed my concerns. I’m not going to rehash it all here.
The share price is down 38% this year, which at first blush seems in line with the others. So, what’s the issue?
The critical point is that Capitec is still trading at a far higher multiple (price / book 3.9x) than the other banks (even Standard Bank is only managing 1x despite the diversification away from SA).
Shareholders are paying this price because of growth expectations, but how much can Capitec really grow in this environment?
It feels like there is limited upside but potentially severe downside in Capitec. The latest round of bank earnings releases has done nothing to change my view.