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With the recent sell-off in South African banking stocks, which are now trading at multi-year low valuations, should an investor buy, hold or climb out all together?
All SA’s big four commercial banks – Standard Bank, FirstRand, Barclays Africa Group and Nedbank – saw their share prices taking a tumble since the final quarter of last year.
The political turmoil surrounding the president’s flip-flopping on who would be heading the Treasury at the start of December, and the subsequent warnings of a possible ratings downgrade, cost banking stocks dearly. But it might be overdone.
“The worst-case scenario of a credit rating downgrade is already priced into our banks’ share prices,” says Arno Smit, chief investment officer at Skyblue Fund Managers.
Standard Bank dropped from a 52-week high of R172.08 on 28 April 2015 to as low as R98.50 on 21 January this year before recovering to R111.28 on 12 February. The stock lost investors a net 24.7% over 12 months, according to data from INET BFA.
FirstRand, which owns First National Bank, fell from a 52-week high of R56.64 on 23 April to as low as R35.57 on 11 December, two days after President Jacob Zuma sacked former finance minister Nhlanhla Nene. It recovered to R44.40 on 12 February, still leaving investors 12% under water.
Barclays Africa Group, owner of Absa, slid from a 52-week high of R187.06 on 28 April to as low as R122.73 on 21 January before recovering to R146.50 on 12 February. The stock lost investors 16.8% over the preceding 12 months.
Nedbank, owned by life-insurer Old Mutual, declined from a 52-week high of R264.66 on 4 August to as low as R165.75 on 21 January, recovering to R183.65 by 12 February. The share lost investors more than 26% over 12 months.
The sudden drop in share prices has boosted the dividend yields on many of these stocks to levels last seen during the 2008 financial crisis when Lehman Brothers – one of the world’s largest financial institutions – went bust, comments Smit.
Smit says he’s comfortable with the fact that his fund’s underlying managers have started to add banking stocks to their portfolios.
The valuation of banks, in terms of price-earnings (P/E) ratios, is the lowest since 2007, says Niël Hougaard, fund analyst at Autus Fund Managers.
“Maybe they’re oversold,” he says. “SA banks historically had strong balance sheets.”
On the flipside, some investors are cautious to add banks to their portfolios.
Banks earn their income through net-interest revenue, or the difference at which they lend out money and borrow money, and non-interest revenue, such as fees.
Credit extension to companies and households drives net-interest revenue, whereas economic activity bolsters non-interest revenue.
With the possibility of a credit-rating downgrade of SA’s government debt, following negative communication by the agencies conducting and proclaiming credit ratings, it is anticipated that banks’ borrowing costs will increase, explains Chris Steward, head of financials at Investec Asset Management.
“There are worries about the pass-through of higher borrowing costs to consumers,” he says.
Luckily, South African banks rely primarily on domestic capital markets to fund their balance sheets, unlike lenders in other emerging markets, which have shown a greater tendency to borrow in dollars and may have to service the debt at much weaker rates of exchange.
SA banks’ foreign borrowing exposure is limited to about 5% of total liabilities, according to Steward.
Nevertheless, he says local banks would struggle to grow the asset side of their balance sheets this year as consumers struggle to cope with already-increased interest rates, higher inflation induced by the weaker rand and lacklustre economic growth.
“We’re unlikely to see the banks meet the market’s expectation of earnings growth of 10%,” he says.
“We should be relatively cautious on the SA banking sector’s outlook. However, SA’s banks are well-regulated with strong capital-adequacy ratios," says Steward.
The rough ride for bank stocks may well not be over, according to Kokkie Kooyman, fund manager at Denker Capital.
“A trigger point for bank stocks is foreign investors who own roughly 30% of our banks’ shares,” he says.
SA banks are expensive when they’re compared with their Turkish and Russian peers, he explains. Earnings at SA banks will be lower due to a lack of economic activity, says Kooyman.
Non-interest revenue at banks depends on a robust economy that spurs activity such as mergers and acquisitions, debt raisings in the capital markets, buyouts between companies, share listings and underwriting services, to list a few.
When the economy struggles and companies keep their cash closely guarded, corporate activity dries up.
That’s why opting for Turkish banks seem a more profitable option, according to Kooyman.
“Foreign investors could get Turkish banks cheaper than SA banks and, as a bonus, the Turkish economy is still growing,” he explains.
This is an excerpt of an article that originally appeared in the 25 February 2016 edition of finweek. To read the full article, buy and download the magazine here.
