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Investec plc is an international specialist bank, operating in South Africa, Europe, UK, Asia and Australia with a focus on delivering financial products and services to a niche client base.
The group has produced solid results during the last couple of years; however, weaker market conditions and overall growth concerns have recently weighed on the stock and the share price has come down from its December 2015 peak of more than R120 to just above R100 at the time of writing.
However, in volatile and irrational markets, good-quality assets can be bought at relatively low prices and Investec is one of them.
With the non-South African part of Investec’s business contributing about 40% to the group’s earnings per share (EPS), it offers a useful rand-hedge component, which is well balanced as we believe that the rand will remain relatively stable for the year. Our view is that most of the negatives surrounding the rand have been factored in already.
We therefore like the mix between offshore and local earnings, as there is a good margin of safety in case the rand weakens again. A stronger rand would benefit earnings as the group results are reported in British pounds.
Divisions
The Investec group consists of three main divisions: Asset Management, Wealth & Investment Management and Specialist Banking.
As at September 2015, the operating profit from its capital light businesses – asset management and wealth and investment management – contributed more than 30% to the group’s operating profit.
With an earnings compound annual growth rate (CAGR) of 23% over the past four years for the UK Wealth & Investment Management division, and the cost-to-income ratio reduced from 84% to 79%, the structural outlook remains positive but the market conditions have prompted us to lower our expectations for this division.
It is the Specialist Banking division that we particularly like, as we believe the restructuring and return on equity (ROE) uplift has not been priced in.
This division contributes roughly 66% of current operating profit and we expect this figure to keep increasing.
An ROE north of 13% for the UK and SA Specialist Banking divisions, together with an increasing loan book and legacy assets being written off as previously promised by management, should lead to a material uplift in the ROE.
Particularly noteworthy is the UK Specialist Banking division, which is currently generating an ROE of 13.4% in an environment where the risk-free rate is 1.95%.
A strong financial position
Investec’s balance sheet remains solid with plenty of cash on hand.
There is a continued push from management to maintain a minimum common equity tier-one capital ratio (which measures a bank’s core equity capital, excluding preference shares and non-controlling interests, against its total risk-weighted assets) of at least 10%, indicating a healthy and financially strong financial position.
Given Investec’s niche client base and more defensive nature, the share normally trades at a premium, or higher price-to-earnings ratio (P/E) when compared to other South African banks.
Currently, Investec plc is trading at a P/E ratio of 14.7, compared with a P/E of 10.6 times for the JSE’s Banking Index and 18.5 times for the JSE’s All Share Index, according to INET BFA data. We therefore see good value in the share, with a price target north of R120.
*Steinman de Bruyn is director at Capilis Asset Managers.
This article originally appeared in the 3 March 2016 edition of finweek. Buy and download the magazine here.
