Discovery will reverse the shocking loss in its UK VitalityLife in the next financial year, and shareholders who are concerned about the knock in the group’s earnings in the six months to December will soon see value coming from the insurance group’s splurge in new initiatives, the company said on Thursday.
The financial services group, which opened a bank in July last year, posted a 7% decline in operating profit to R3.55 billion in the six months to December. This decline widened to 11% when looking at its headline earnings, the measure of profit that focuses solely on operations. A record level of expenditure on new business initiatives and problems in the UK life insurance business, VitalityLife, were the main culprits causing the decline.
VitalityLife, which saw operating profit dive 144% to a £7.2 million loss (-R140m) was knocked by declines in interest rates in the UK as a result of quantitive easing, as well as high policy lapse rates by customers. But its numbers were worsened by Discovery’s decision to intervene by hedging against the interest rate decline, adding a cost to a company whose profitability was already sitting at zero.
"I think no matter what we did, the interest rate drop would have affected the profitability," said Discovery CEO, Adrian Gore.
The record level of spending hurting profits
As for the other element that ate into Discovery’s profits – the R1 billion expenditure in new initiatives in the six months alone – Gore said he understands that as a large listed company, stakeholders expect a steady progression. However, the value that will be created by growing organically will compensate for the profit declines, he said. Discovery took a strategic decision from its inception instead of acquisitions. Gore said while this is a more laborious route, this gives the company "quality" businesses it can never acquire.
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"If you look at the actual capital put into growing Discovery versus the value, if you look at our emerging business block, Ping An Health, Vitality Group and Discovery Insure, those businesses collectively contribute over half-a-billion rand profit stream growing at 20% a year now. If we were to acquire that, it would probably cost us five times more than it cost us to build them," said Gore.
He said Discovery’s shareholders have been tolerant of the volatility that comes with "building brick-by-brick", and even though the company faces a lot of public criticism, most investors tend to stand with the management’s vision.
As a whole, Discovery spent R5.4 billion on growing its businesses in the six months to December, including the R1 billion that went into new initiatives, including Discovery Bank. The R1 billion alone represented an increase of 81% compared to the previous comparable period. Gore said on new initiatives and it will be coming down from here.
"The issue with spending on growth is, you’ve got to be clear about what you are trying to achieve, what you set out to spend, whether you are on target and if you are above it, explain it. If these [new] businesses get to scale, if the bank is as successful as we hope it will be, it will be worth every bit of pain we’ve been through," said Gore, adding that Discovery has play open cards with investors.
Discovery Bank now has 78 000 clients with 180 000 active accounts. The group is aiming for 500 000 active accounts positively spending and borrowing from it to consider the bank "successful".
"That’s doable. We are quite comfortable. We are tracking very well against the business plan. We are very excited about the quality and quantum of clients we have. It’s only six months but we are very impresses," said Gore.
Investment analyst, Chris Gilmour, said while Discovery is facing challenges, like most other South African companies, he expected the group to address them because it usually finds a unique way to deals with such. He added that the group’s success in taking its home-grown technology globally demonstrated that it could achieve what its management has set its mind on.