South Africa’s banks offer cheap nuggets in the junk
The stock market’s long-held assumption was that South Africa would lose its last investment-grade rating with Moody's following a long, well-signposted process, leaving ample time to price in the bad news.
The fact that the rating was finally lost in the midst of a global public health and financial crisis means that value investment opportunities in the country’s banks have been created. Fitch and Moody’s have also downgraded the country’s banks to junk.
South African banks are now at historically cheap levels versus emerging-market peers, says Paul Hollingworth, managing director at Creative Portfolios in London. Nedbank is the pick of the bunch from a value perspective: the shares are “just too cheap to ignore as its share price has become overly detached from the others.”
- Nedbank’s shares have lost 62% of their value since January 1.
- The current share price of 8,580 cents gives a price-to-earnings (PE) ratio of 3 and a dividend yield of 17%.
- The bank has said that its downgrade will not have a material impact on its capital position.
- Net assets per share stood at 18,204 cents at the end of 2019, meaning the stock is priced at less than half of its book value.
- Despite South Africa’s downturn, the bank has succeeded in growing NAV at a compound annual rate of 4.5% since 2015.
- The full-year dividend in 2019 was 1,415 cents, which was covered 1.84 times by earnings.
- The ex-dividend date for the next payment is April 15, meaning that investors need to buy the shares by April 14 to be entitled to the final gross 2019 payment of 695 cents.
FirstRand and Standard Bank also have “more compelling valuations than in the past,” Hollingworth says. All of South Africa’s main banks face the same challenges and have to spend and innovate to reduce inefficiencies, but he’s confident they can meet the challenge.
- “FirstRand is a highly prudent well-managed lender while Standard Bank always struck us as innovative but circumspect,” Hollingworth writes in research published on Smart Karma.
- “These are investment grade banks trading at a junk rating.”
Buying South African banks as a recovery play is not a short-term investment. Economic recovery in South Africa looks like being “a long hard slog,” Hollingworth says, putting the odds of continued or worsening economic stress at 70%.
Neither is it risk free: Hollingworth sees a 10% chance of “total disaster” for the economy. Much will depend on reforming state power utility Eskom, which Hollingworth sees as “a central driver for different scenarios.”
- If South Africa can reform Eskom’s governance and achieve a more efficient operational structure, “they will be able to see that reform works and can get the religion. They have to get this right.”
Moves by South Africa’s Prudential Authority to ease liquidity requirements on banks helps to reduce the risks.
- From April 1, the banks have to meet a revised liquidity coverage ratio of 80% of Basel 3 regulations.
- According to the Bureau for Economic Research at Stellenbosch University, the easing of the requirement will “provide temporary liquidity relief to banks and help to ensure the continued flow of credit to the real economy.”
The Bottom Line
Investors who think that South Africa is capable of reform are unlikely to have a better chance to pick up cheap shares in the country’s strongest banks.