CAPITEC BANK [JSE:CPI] produced a quality set of numbers for the year to 28 February 2017, growing earnings per share by 17.7% to 3281 cents. Growth slowed from 19.4% in the first half to 16.4% in the second half. The annual dividend of 1250 cents is 18.5% higher. This is achieved in an increasingly tough operating environment.
Growth in transaction fee income and deposits were highlights. Provisioning remains prudent and the balance sheet sound and well capitalised – there is no need for new equity although Capitec will tap the debt capital markets from time to time, where demand for the company’s bonds is strong. Capitec has acquired an interest in online consumer finance company Creamfinance, registered in Cyprus.
Whilst this is unlikely to move the needle on earnings in the short term, the deal supports Capitec’s digital strategy. Capitec is expensive but, historically, this is for good reason. On my adjusted earnings model, I have three-year compound growth in earnings of 15.6%. I maintain FirstRand as preferred exposure of the big four but Capitec provides a differentiated alternative that is unlikely to disappoint. The current share price is a little pricey for new money, not least given the volatile and unpredictable nature of South Africa’s politics and the sensitivity of banking stocks to bond yields.
What you need to know
I am comfortable that the business remains on solid ground and continuing to innovate and fine-tune its credit granting criteria. As the company brings in previously unbanked customers and offers an attractive alternative to the big four, so in turn has the client base grown significantly.
But this growth is hard won, as the bank toughs it out in an increasingly stressed operating environment.
Data collated by Capitec, adjusted for inflation, indicates lower cash inflows across all income categories. Furthermore, of performing customers, cash availability has dwindled whilst the proportion with no inflow has risen sharply. Credit applications are up but acceptance rates have declined whilst the proportion taken up has fallen .
There are two highlights - transaction fee income and deposits.
Transaction fee income continues to increase ahead of other income, rising by 30% this past year. This means less reliance on credit. Operating expenses grew by 18% and transaction fee income now cover 72% of these costs. The aim is to get to 100% by 2020 and should be assisted by encouraging more customers to use self-help and cost effective solutions through technology
Deposits are up substantially, which is favourable for funding and a sign of confidence in the bank. Retail call savings are up 25% in part due to client growth of 18% to 8.6 million customers. Retail fixed-term savings grew by 31% .
Return on equity at 27% is higher than targeted and should be reduced to around 25% as product pricing is lowered. Lower income relative to capital deployed is compensated for by higher volume of business.
The weighted average outstanding term of the loan book has reduced to 38 months whilst the average loan size is up to R7 761 due to an increase in long-term loans. The total number of loans granted fell from 3.7 million to 3.5 million whilst stricter credit granting criteria resulted in a lower bad debt provision movement.
The bank is growing the staff complement and branch network. Branch opening hours are substantially more flexible than the big four banks. Smaller microbranches are also set to be rolled out.
Capitec acquired an interest in Creamfinance, an online lending group registered in Cyprus. The initial 40% is for €21m over three tranches. There is a put option for a further 9%.
Creamfinance has targeted thirty countries and currently operates in Eastern Europe, Mexico, and Denmark. There is no intention to open physical branches. Whilst Creamfinance is small it has similarities with Capitec and supports Capitec’s digital strategy. There will be useful learnings for both parties.
There is no intention to enter the asset-backed lending market. Through a relationship with SA Home Loans, those customers able to qualify for a mortgage are referred by Capitec.
Capitec is expensive but, historically, this is for good reason. On my adjusted earnings model, I have three-year compound growth in earnings of 15.6%. At a share price of R791 the PEG ratio is 1.55x, which is not out of line with the big four banks.
However, the crucial difference between the rating of the big four and Capitec is the capacity to maintain earnings growth in the mid to high teens. If earnings growth stalls, then the share price of Capitec would either have to tread water for some time until the rating normalised to the maturity of the business cycle or the share price would have to fall steeply.
This past week, Capitec breached my earlier target price of R805 before retreating. With the passage of time I have increased my fair value to R750 and the target price to R812. The current level is a little pricey for new money, not least given the volatile and unpredictable nature of South Africa’s politics and the sensitivity of banking stocks to bond yields.
Capitec, FirstRand, Barclays Africa Group, Nedbank, and Standard Bank based to 100 since 2012
*Mark N Ingham, independent analyst on behalf of the EasyEquities trading team.