Banks: where to find value

Johannesburg - Banking share prices are again heading for October's highs, but analysts are not entirely certain as to where the expected greater earnings growth - which theoretically should underpin this - will come from.

On a comparative basis South African banks have, since March's lows, averaged poorer performances than those of international banks, despite the recent sharp increases in their share prices.

The greater optimism within the sector is being driven by technical analysis that shows a peaking of bad debts in the first half of this year. Concerns that impairments at corporate subsidiaries will rise are possibly exaggerated.

In a research report Citi says that growth in advances will remain muted. Banks will be unable to show much growth in interest income throughout 2009. Non-interest income, which depends largely on levies and commissions, might perform better.

For this year and next year growth is expected to be the lowest in 20 years.

The huge extent of bad debts on banks' books is reflected in comparative figures, which show a rise from R7.2bn in 2006 and R12bn in 2007 to a colossal R38bn this year.

Costs are being well contained, with banks' cost ratios in the first half of this year having declined in real terms, if inflation is taken into account.

All these factors have reduced the profitability of banks' advances to a minimum as returns have fallen below the cost of capital. But, if profit margins recover, earnings could surprise on the upside, says Citi.

Citi predicts average earnings growth of 20.6% for next year, possibly rising to 32% in 2011.

FirstRand currently has the highest rating on the JSE at a price-earnings multiple (p:e) of 14, followed by Standard Bank's 12, Absa's 10.7 and Nedbank's 8.8.

FirstRand shares are currently trading at R17.25 on the JSE, but Citi's target price is R18.80 with a 9%-odd discount, which explains the recent improvement in FirstRand's price.

Indications are that most of the good news is already being reflected in the FirstRand share price, so better value can be found at the other banks.

Citi expects the best performance to come from Standard Bank, which could rise, from a floor of R95, as high as R126.40, giving investors a return of more than 30%. Nedbank and Absa could both grow 21% to 24% if conditions are favourable.

- Sake24.com

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