Episode Transcript
The Finance Ghost: Welcome to episode 233 of Magic Markets. We've just finished recording our Premium show for the week on Exor, the European investment holding company. Some really interesting stuff there, Moe, and part of our efforts to just help our subscribers look beyond the US market with, I've got to say, somewhat mixed results. It's quite hard to find stuff outside of the US that really jumps out at you, but nonetheless we persevere and look at some of these names.
And today's show is also going to be a bit of a look beyond the US, even though it's banking earnings week in the US and we can pick up on some of those themes from next week. You mentioned to me that it would be quite good to cover off some South African stuff for a change and specifically some of the financial services names on the side, with of course a bit of a macro overlay because we can't let you not have a macro overlay, Moe. What else will you do if not that?
Mohammed Nalla: Ghost, I'm so glad that you're willing to indulge me this week and I'll tell our listeners why, right? We've mentioned how the US is kicking off earnings season. It's front-loaded with a lot of the banks, but I was looking at the quarterly performances of the various sectors, both in the US and down in South Africa. And what's been very interesting is that in Q1 of this year we actually had financials that were performing really well internationally.
And then this quarter they seem to take a little bit of a step backward. And if I look at just the JSE's main sectors, financials were probably one of the underperformers. Yes, the overall market had a pretty decent quarter, but financials were one of the underperformers and I was wondering why this would be the case because again, you've mentioned that macro lens - if I apply a macro lens down in South Africa, we actually had the SARB cut rates by 25 basis points. I think a sigh of relief from a lot of consumers out there.
And what this means from a macro perspective is that you may have actually seen the shorter end of your yield curve down in South Africa steepen a little bit because the short-end actually moved lower, the longer-end stayed anchored. And when you get that happening, remember, banks at the end of the day are paying you the saver, they're paying you the lower interest rate, but they're actually out there lending money at the longer end of the yield curve. And so you would expect that to be a positive impetus for banks, so that underperformance that we saw, maybe just not even on the quarter, but certainly last week as well, I think some of the financial stocks in South Africa were the underperformers relative to sectors like resources. We know why resources are doing well. Gold's been a strong story, but that for me was interesting and I said, let me pick the Ghost's brain in terms of what's actually happening underlying the headline macro prints underlying the sector level approach.
What's happening with banks in South Africa? What's happening with insurers, or life insurers, or medical aid companies? Because it is a very diverse, well-developed sector down in South Africa. It's probably one of the sectors where you get a reasonable amount of differentiation, I guess, within a sector down in South Africa. So I think there's a lot of value in unpacking what some of those sub themes actually are down in South Africa. Ghost, I'm going to pause there because I'm going to ask you the direct question. Maybe before going all the way down into the micro, if we look at banks versus insurers versus medical aid companies, where has the main action been on the ground in terms of the underlying performance versus the share price performances?
The Finance Ghost: Yeah, so I think it's really the insurance side that has done quite well versus some of the others and a couple of the banks. But we'll dig into those reasons why. The medical aid side is really, I guess, Discovery and then a bunch of businesses that perhaps sell some of that stuff and we can talk about where the money is made there and some of the brokerages as well.
But just to set the scene, the financial sector - if you pull a minimum disclosure document of something like the Satrix Top40 ETF for example, then financial exposure is around 30%. So if you buy a Top40 ETF, almost a third of your money sits in the financials sector on the JSE and obviously that is a significant exposure. This is a very important area on the local market, it really is.
I think Moe, maybe let me start with the banks. So, as you correctly said, we've had a little bit of a rates reduction in South Africa and I think therein lies the exact problem, is it's a small reduction - so much as certain parts of the curve might move in a particular direction, the reality is that if you are a borrower from a bank, particularly a retail borrower, very good chance your loan is directly linked to prime. So the bank's asset, which is the money that they loaned to you, the pricing on that goes down as soon as prime drops. That squeezes their margin, which is not good.
Now, what should offset this is an uptick in credit demand. In other words, I as a consumer look at this and say, well, rates are coming down, I have a bit more money, this is fantastic. Let me go buy a car or let me go buy a house or let me go and borrow money. But consumers are not doing this because 25 basis points doesn't do it, it just doesn't. So, it's actually such a small decrease that all it does is basically hit the bank on net interest margin, but then it doesn't allow for an uptick in loans and advances to make up for it.
Corporates are not borrowing enough either. They are very sophisticated borrowers, so they squeeze the banks. You have a situation where good quality assets in South Africa are not that easy to find and there are a lot of banks running around, relative perhaps to some of the high quality corporate lending opportunities. So these corporates know that, and they can squeeze the banks and they can go and do a medium-term note program on the JSE as an alternative. We have a very vibrant listed debt market as well. The banks don't have it all their way anywhere really. And a 25 basis points drop actually hurts them.
Now what's quite interesting is if you look at the relative share price performances because of course the banks have different exposures. And you might be interested to know Moe that banks like Standard Bank for example and ABSA have been relatively better off, at least last time I looked certainly than the likes of Nedbank. And that comes down to exposure in Africa at the end of the day. Because of the weaker dollar, that's released some of the pressure on African currency, some of the pressure on African corporates. I mean just look at the MTN share price as a very good example. You've got a situation where having extensive exposure to Africa has actually been good news for a couple of these banks, whereas Nedbank has got a very SA-focused strategy. Yes, they have some stuff in Africa, but not to the same extent as the others.
When the South African story gets a bit worse, when you have things like margins under pressure, less demand for credit, unfortunately Nedbank seems to really bear the brunt of that. And then you've got the likes of Capitec as an exception. It just always goes up and that's just a function of how much market share they just keep on winning. Every single time we look, they're just winning share and they're adding products and everything else. So that's where that share price performance is coming from.
Mohammed Nalla: I think that's fantastic. And I mean I've got a couple of questions already that just spin out of that before we even move on from the banks specifically.
Yes, I agree with you. 25 basis points is neither here nor there. It's not going to make a dent in terms of consumers’ underlying decisions. It might help the overly indebted consumer, but again it's really at the margins.
My question is this, right Ghost, is that 25 basis points is not going to move the needle in terms of volumes, but does it make that much of a difference when you're looking at the bank's relative credit exposures or risk? Because there are two sides of the coin. One is obviously how much opportunity you can take, the other is risk. So what have the underlying trends on non-performing loans or credit loss ratios done across the various banks? And then specifically tied into your last point, because you've mentioned how Nedbank for example gets hammered a lot harder than some of the competitors who have a more diversified, a greater Africa exposure - does that greater Africa exposure actually come with more credit risk? That's a real question I have because I have no idea.
And the reason I ask that is that the performance of other South African corporates that have gone onto the continent and here specifically, I'm thinking around some of the big telcos, they've had a terrible time. Even some of the retailers haven't had a great time on the African continent. What have the banks’ experience has been on the continent? Is it just the growth uplift and what does that mean for the underlying risk?
The Finance Ghost: Yeah, so it's a great question. I don't have all of the underlying breakdowns of non-performing loans at hand, but what I can tell you is that in terms of credit loss ratios, what we have seen at the banks recently, the narrative has generally been one of our credit loss ratios coming from a level where it was above our through-the-cycle target range, now it's coming into range. So credit quality improving is the overall theme, definitely. And that is helping earnings, that's the one area where things have seen a bit of a boost. But I think the market is smart enough to know that it's a step-change, and once you're in the through-the-cycle target range next year, what you need to drive growth is loans and advances demand. At the end of the day, it's credit demand, it's not impairments, it's not credit loss ratios. That happens once you get into range and it's done. So that's the one point I wanted to make there.
On the Africa stuff, it is true that we've had a lot of South African corporates who have gone and learned some very hard lessons. But I think what's also happened is that has helped the local banks also learn some lessons, even living vicariously through them and in some cases directly exposed. Because I do see much more maturity in the way these companies talk about Africa and deal with Africa.10, 15, 20 years ago - it was kind of, throw darts, we've got to do something about this continent. We've got to show that there's growth here. Let's just talk about Africa and hope for the best. I think it's way more nuanced than that. There's a way better understanding that East Africa and West Africa are completely different places to the countries that are just bordering us, versus North Africa, where we don't often see South African businesses play.
And we'll move on to insurance, I guess soon. And there we can easily talk about something like Sanlam and all the effort that they've put into building a pan-African insurance business. So they are getting it right.
As for the banks, I'll just give you some share prices quickly because the charts really says a lot. So the only one year-to-date of the big five in the green is Capitec, up 9%. That's the only one. Standard bank slightly red. FirstRand down 4%. Absa down 7.5%. Nedbank down 16%.
So it really says to you that the shine, that whole GNU-exuberance blah, blah, blah, blah, blah, it's not coming through in terms of growth in loans and advances.
And there's another disruptive factor that I just want to put on the table, which is fintech in retail lending. What's happening is South Africans are not necessarily going and buying homes or borrowing money to buy cars because 25 basis points doesn't cut it. And they're already heavily indebted, low economic growth, but they are buying discretionary items at retailers. However, at the point of sale these days, you now get Buy Now Pay Later, you don't necessarily need to be running overdrafts as much etc etc. and payday lending, all that kind of stuff. There are alternatives. And Buy Now Pay later is taking a nice little chunk of the market and I think is going to start impacting more and more of the demand for credit among retail borrowers.
So I'm actually long a company called HomeChoice which owns PayJustMow, or at least controls it, which is a Buy Now Pay Later business. Very illiquid stock. I'm up nicely at the moment. But the illiquidity is part of that, it is one of those prices that jumps around a lot. But that for me is a direct play on disruption in this space because I do think that there's even still more of it to come. The banks are under fire from all sides.
Mohammed Nalla: I think that disruptor point you raise is so interesting because, whether you like the Buy Now Pay Later macro theme that's happening, you get that up here in North America, Klarna’s all over the show, people joking around the fact that you go buy your Chipotle meal and they offer you to pay that meal down in four instalments. I mean, that's, it's horrible! So, whether you like the trend or not, I think the disruption is certainly there. And banks on the receiving end of that.
I want to pivot because you mentioned it, right? And we've mentioned how the financial sector in South Africa is really so diversified, you've touched on the insurers. Let's maybe go there because there's an old saying that says if you look at the core CBDs in whichever country you operate in, you just have to see who's owning the biggest buildings. And initially it used to be the banks, then it was the life cos, and now I think it's the lawyers - we can't invest in any listed law firms, unfortunately. But in the finance sector, what have the insurers and the wealth managers been doing? Because surely if the banks are under pressure, something in that sector, in the financial sector is doing - South Africa has a very strong financial sector. You mentioned Sanlam. I've been following them at a bit of a distance and I've seen them do some very interesting international deals. They've got exposure to some interesting international markets. Let's maybe touch on that point with Sanlam, but also some of the other players, like maybe a Momentum, maybe some of the asset managers like Coronation, what's happening in that segment of this financial sector.
The Finance Ghost: So I'll speak - I'll give a little bit of time to traditional asset management, and then as you mentioned, names like Momentum, there are others like PSG, Alexander, Forbes - I think the overarching takeout from there is that the model that is working is distribution rather than sitting back and just managing assets and hoping they find you. If you look at a business like Coronation compared to the performance of something like PSG, you've got to have a force of salespeople out there going and hunting for assets. That is what works. If you don't have that, it really is a serious challenge in South Africa. So I think that covers off hopefully the asset manager point without diving into lots of detail because I think there is more interesting detail for us to cover while we have time, which is around these insurance houses.
So, if we look at the likes of Sanlam, share price performance over five years, 35%. That's not CAGR, I wish it was CAGR, It's total. Old Mutual down 8%. That is a massive, massive difference. Now there's new management in place at Old Mutual with effect from June. But at the moment it looks like Sanlam is where all the growth is. In their first quarter update, net result from financial services was up 15%, net operational earnings were up 22%. And it's general insurance that is really driving this forward. It's not necessarily the life insurance side, etc. That's good old short term insurance and some of their businesses in that space because of course they've got the big stake in Santam. And if you look over five years, Santam’s share price is up 67%. So that shows you where the action has actually been.
They've also got businesses across Africa, they've got stuff in India. So Sanlam has done a great job of chasing growth in emerging markets, in high growth areas and that's why their share price has done well. And Moe, do you know what Old Mutual is busy building at the moment? Do you know what their big strategic push is?
Mohammed Nalla: I'm going to laugh. I think you mentioned it off air. So it's a bit of a cheat. I mean, I was laughing because you said it was a bank and I was like, what? Why are they doing a bank? They owned a big stake in Nedbank, then they made a big song and dance around divesting from that. So I thought Old Mutual was done with banking. But you told me it's a bank, am I right?
The Finance Ghost: Yeah, it's a bank. So Old Mutual's big thing now is going and build a bank. So what are they going to do differently? Why do they need to build a bank? I have no idea. I've got to tell you, I have no idea. And I will show you now with a couple of interesting data points as we start to bring this to a close of why I just don't see the point.
You mentioned medical aid companies earlier. Discovery. Now Discovery, they also did what Moe? Built a bank! I'll just answer it for you because it's so obvious.
Mohammed Nalla: Bank!
The Finance Ghost: There we go. Thank you. In the latest interim period, would you like to guess, did Discovery bank make a profit or a loss? Bear in mind this thing's been around for a few years now.
Mohammed Nalla: That's a hard no…
The Finance Ghost: Hard no…
Mohammed Nalla: …loss.
The Finance Ghost: …because you don't want to guess? Yeah, it's a loss. Exactly.
Mohammed Nalla: No, it's a loss. It's a hard no as in they didn't make any money.
The Finance Ghost: Yeah, yeah, exactly. It's a normal - I thought it was a hard no, you didn't want to guess! - it's a normalised loss of R145 million. Ouch.
Now, it is growing quickly. The loss has gotten smaller every year. But it is a long J-curve, it's a multi-year J-curve where you lose money, lose money, lose money and then finally, if you're lucky, you start to make money. Now keep in mind Discovery's distribution power and all the synergies with Vitality. And they have a lot of higher income clients, Platinum, Vitality, lots of different products. You would think that they were actually a decent candidate to go and start a bank, right? I can understand that.
What is Old Mutual planning to do with this bank? I really don't get it. So I'll give you some more data points around Discovery. 1.1 million clients. Based on their last report, deposits were up 27% to R21.2 billion. And advances were up 37% to R7.8 billion. So not so easy to deploy the money that comes in, either.
Now here's another one for you. Recently Lesaka announced the acquisition of Bank Zero. Bank Zero also trying to be a disruptor, trying to come in as a digital only, interesting, clever story, etc. Bank Zero for all their efforts made it to a deposit base of R400 million. That's with a “m” okay. And 40,000 funded accounts. So deposit base R400 million. I just gave you the Discovery bank deposit base - R21 billion. And Discovery cannot make a profit yet on a deposit base of R21 billion.
So what is Old Mutual seeing in this market? Why are they going here?
The return on equity for local banks is in low- to mid-teens. The insurance companies get a return on equity of over 20%, generally speaking when I look, so I just don't get it. Sanlam is out there chasing growth with a model that makes money in regions that are high growth. And Old Mutual is saying, hey, we want to start a bank. And that's why the share price differential looks the way it looks. And that's why financials on the JSE will give you such divergent performance.
Mohammed Nalla: Why don't they just buy back their Nedbank stake? You mentioned how badly the Nedbank share price is done. They could just go back and buy the Nedbank stake and hey, guess what, Old Mutual, you've got your old bank strategy back again.
It's just fascinating. I think you've indicated how the banks are not the sweet spot of financials. We've got the closure of Sasfin bank, certainly the commercial operations, which I think caught some people by surprise, but they've been performing poorly for quite some time.
I don't want to lose track of time. I want to touch on what's happening with other players like Momentum. They operate in the wealth space. Is wealth a valuable segment in the financial services industry? You mentioned insurance is where all the action is. But what's happening in that wealth space? Because I think there's wealth advisors, you've mentioned Alexander Forbes, they operate in a very different space to any of the companies you've mentioned. So maybe give us a quick wrap on that as we bring the show to a close.
The Finance Ghost: Yeah, it's good place to finish. Alex Forbes has been doing lots and lots of restructuring-type stuff, lots of deals. It makes it a bit messy. I think if we have a look at Momentum and then PSG Financial Services and then Coronation again, the share price divergence is just incredible.
So over five years, Coronation is basically flat, minus 2%, so nothing. PSG Financial Services +208%. Just to give you an idea, Momentum is up 83%. Now, this is over five years, pandemic lows. But the point is, that's also a pandemic low for Coronation, right? And that's gone absolutely nowhere.
Like I said, you’ve gotta go out there, you’ve gotta hunt for these assets and they are getting really good return on equity as a result. Momentum living up to their name in the last year actually, up 44%. PSG Financial Services also really good, up 23% and Coronation up 3%. So it's just really difficult if you're going to sit back and wait for assets - and unfortunately, when I read those Coronation reports, they always talk about the South African savings culture, blah, blah, blah, it's really hard to grow. These things fall flat, in my opinion. When you're earning a lot of money as an executive team, just sitting back and saying, wow, it's hard to grow, it doesn't cut it for me as an investor. Then I really don't understand why we need to pay people an absolute fortune to sit there and throw their hands up in the air and say, ooh, it's all too difficult.
Because out there you've got companies like PSG, like Momentum, actually doing something about it. They're actually investing in growth areas. Look at the performance of the likes of Sanlam relative to Old Mutual. As an investor, at the end of the day, all these companies are competing for our capital and you've got to then look for the management teams who are actually getting stuff done, as opposed to the ones who are sitting back and saying, ugh, it's all too difficult.
Mohammed Nalla: I like it Ghost. I think you've certainly synthesised a lot of that for me in that you can't just look at this on a sector level. That's the danger of passive investing. Even if you're doing it on a sector basis, this becomes a stock picker's market. I think given the breadth of that particular sector in the JSE you mentioned, it's 30% of the overall index, that's large. I like the sector just generally because you get this kind of differentiation in the South African market, which otherwise could be quite narrow. And I think you've given me some thought starters in terms of individual stock names to go and have a look at, because I believe some of the underlying themes will benefit companies that are able to execute with excellence in that space.
Unfortunately, that's where we've got to leave the show this week. We hope you've enjoyed it. Hit us up on social media. It's @MagicMarketsPod, @FinanceGhost and @MohammedNalla, all on X. Or go and find us on LinkedIn. Pop us a note on there with your thoughts. Until next week, same time, same place. Thanks and Cheers.
The Finance Ghost: Ciao.
This podcast is for informational purposes only and is not financial or investment advice. Please speak to your personal financial advisor.
