The Denker Capital financials team recently met with the management teams of some of the South African banks and insurers. In this episode, the team shares the common threads and growth prospects of a number of these companies and highlights the investment opportunities amongst them.
Morning Kokkie, nice to see you. We’ve got a full squad here today. I’m joined also by Barry de Kock, Craig Metherell and Ben Kooyman – the full global financials team. Let’s get straight into things. You guys have been on the road in South Africa in the last week or so. What are the common threads you’ve noticed in the market, and what is the feedback that you’ve had in terms of the stocks that you hold? In SA, it would be the Nedgroup Investments Financials Fund where people would be able to access your SA capability. What are you really positive about?
Thanks, Nigel. It was a good week and a half, we managed to see 10 CEOs and CFOs of all the major banks and some of the insurers as well. Doing it in such a short space of time was actually quite nice because you really get a good picture, and we asked them the same questions. We weren’t concerned about the next quarter’s results but more the strategic direction, as to where they are going to go. What is always nice in South Africa is, because over the years we’ve built up a very good relationship with the CEOs, often we find that an hour has been set aside and after an hour and a half the CEO realises they’re late for their next meeting. It was very relaxed. It’s more about strategy, and the CEOs and CFOs like talking about that.
What really struck us in these meetings was, firstly, that 2023 is going to be a tough year but, most important, that nobody was really concerned about any risk to the business or even risk to the economy. In that regard, time and again, everybody commented on the effect that Covid has had in that businesses that were marginal, that were leveraged, that were running low on stock, that were just making it – they fell over in the end. So, the system is a lot stronger now and businesses have adapted. The businesses are running lower debt, higher stock levels and are operationally cleaner. I think that is the key. I think the big surprise in 2023/24 is going to be how well the banks and insurers are going to come through this with low bad debts in terms of being very well provisioned and very cautious in lending.
The second thing to me was the effect of digitalisation. They’ve all spent a lot of money on digitising their businesses – as Nedbank call it, ‘end-to-end refreshment’. The manual systems and the labour-intensive systems have been taken out. Craig can tell you about the big battle they still have with cash. They’re trying to get cash out of the system because cash is very expensive. Then, what the differentiators were for us, are the cultures at businesses like Absa, FirstRand and Capitec – very strong on the culture they’re trying to generate in the business (employees feel like owners).
The last one, and I’ll maybe ask each of the analysts quickly to comment on that, is the growth strategies. Because the growth strategies are quite different in terms of where they want to take market share.
I think that’s a great place to go, in terms of what would interest the listeners. Maybe you could kick off and go round the team in the various areas and highlight some of those business that have really interesting growth strategies.
Let’s ask Craig first on Standard Bank. Standard Bank always was called the big gorilla because they were the biggest. They’ve faulted a bit on their technology front. We had very good meetings there and obviously they’re addressing it, but what differentiates them is where they want to grow. Craig can give more insight on that.
Thanks, Kokkie. What came out of the meetings, focussing on the Big Four firstly, is that growth strategies have started to diverge a bit. This has been happening over the years, but this divergence from a strategic point of view is playing out now. Standard Bank comes to mind – they’re very committed to their African growth story. This is really a diversification strategy and they believe that they can grow their African operations to 50% of revenues. It will come with challenges. There are other concerns in those markets, such as the dollar strength and the inflationary aspects of those economies, but Standard Bank is really committed to driving that strategy and they have some great businesses in Nigeria and Kenya but there are some concerns in some markets like Ghana. But they’ve taken this through the cycle approach, to their capital allocation strategies and believe that over the course of time, this is the best strategy for them.
Moving on to Absa, they’re following a similar approach to Standard Bank, maybe not as exposed to Africa but they certainly feel, like Standard Bank do, that Africa will drive the growth. There are better growth opportunities out there. These economies are growing faster than South Africa, which does face some challenges. However, Absa believes that if they remain focussed and disciplined, as Kokkie alluded to earlier, with the separation of Barclays having taken place, that this is really a key engine for growth for them. At the same time, they do think there’s a lot to do in their home market here in South Africa. Just touching on culture a bit quickly: Absa strikes me as a sports team that’s winning all the time and is on a real roll because of how high confidence is and that culture that’s permeated through the staff and the organisation is really playing out. They’re doing some great things and we really like what they’re doing at the moment. It is one of our larger holdings in the Nedgroup Investments Financials Fund. Of the banks, it’s actually our second-largest exposure after FirstRand – 12% of the fund.
FirstRand is 16% of the fund. And what came through from Alan Pullinger, the CEO of FirstRand, is that they’re very committed to the South African story. They do have the UK growth story as well, in Aldermore and the MotoNovo business that sits under Aldermore in the UK. But having said that, even if it were to double, it’s still such a small part of the business, that it’s not really going to move the needle. But they believe that there’s some really exciting, niche opportunities in that space to grow because, in Alan’s own words, they’re like the elephant in South Africa – they can’t really manoeuvre too quickly, but they’re really good at what they do. Whereas in the UK, they’re more like the mouse, where they can be a bit more agile and nimble and take some market share here and there.
A cheetah might be more appropriate.
Yes, a cheetah might be more appropriate – thanks Kokkie.
Then there’s Nedbank. Nedbank has faced some challenges over the years with its Nigerian or Western African exposure in Ecobank or ETI, some people might know it. It is exposed to some very cyclical markets there and they are fully committed. It’s slightly different to the likes of Standard Bank and Absa, where it’s a focussed investment, where they don’t have much influence on the strategy, despite two board seats. But they believe that that’s turned the corner and there are some exciting prospects ahead for them.
Then maybe just touching outside the top four with Investec, which we also have quite high exposure to. It’s close to 10% now in the Nedgroup fund. Given their specialist nature, they’re finding some really exciting niche opportunities through their trade financing relationships and arrangements across the continent. But again, the words ‘focus’ and ‘discipline’ come up. These management teams are very committed in terms of how they go about capital allocation decisions and determining growth strategies.
Then Capitec here in South Africa, similar to FirstRand, is South Africa focussed but really playing in a different market, trying to attack incumbents in the banking space and in the insurance space now. We’re watching them very closely at the moment and are excited about what they’re doing. That’s how I’d run through them from a growth point of view.
Nigel, maybe important to point out also for listeners: These holdings are in our SA equity funds as well. In fact, all the Denker funds reflect the views of the global financials team. When we like Absa, let’s say for the Nedgroup Investments Financials Fund which we manage, the Denker funds may add that as well.
Important for Barry, the insurance stock that we’ve been adding to has been the old Momentum (MMI). Barry, over to you.
Barry de Kock:
Sure, Kokkie. Following on some of your opening comments on culture and focus, Momentum has certainly over the last few years, since the current management took over, changed its focus from being internally focussed and fixing a number of internal issues within the business to now having sorted that out and being outward focussed. They’re looking at market share again, looking at where they can grow and looking at how they can, to quote one of Kokkie’s favourite phrases, be ‘on the front foot’.
Some of our key takeaways from the meeting was that firstly, for the sector in general but for the business specifically, higher interest rates and a steeper yield curve are good for the business. As you can imagine, over the years the business have been under a bit of pressure from lower rates, so it’s a nice relief to have that. Secondly, it’s a highly cash generative business. It’s a stable business and the yield on the dividend is 7.5%, so there you have quite a nice support to your investment with that yield.
From a growth perspective, one of the highlights I took away was the optionality that you have in India. I think it’s slightly different to what we’ve seen in their peers in the local market, in that they’ve partnered with a very strong health insurance partner in India, called Aditya Birla. That business has been growing exceptionally fast into a very underpenetrated, very big market in India. Just to give you a sense, they target over the next couple of years 40% growth in premiums per year. They’ve recently had a third partner join, the Abu Dhabi Investment Authority, who injected a bunch of capital into the business. Firstly, this reduces the capital strain that Momentum would’ve put into the business to continue to grow. Secondly, the other interesting takeaway there is that they valued the business in the JV in India at three times what Momentum is currently holding it on their books at. A lot of upside there over the long term, provided they can execute and we think they will.
Another exciting part of Momentum is Guardrisk. That is one of their non-life businesses within the group, which is slowly taking on more underwriting risk into a very attractive underwriting environment. We think there is a lot of opportunity for growth and success there. And again, management has a very measured approach to these things, to grow well and to grow profitably. To finish off, we think the shares are extremely attractively valued. I mentioned the dividend yield earlier, but to give you another sense – the shares are trading at around R17 today and the embedded value of the shares are R29.70, and that’s as per management’s calculations. I think there’s still a lot of way to go to close that discount.
Nigel, an important point to add is that both globally and in South Africa, one of our key focusses is always to find undiscovered gems. To find those companies that can outgrow the market for 10 years. Generally, the stocks we mentioned tend to be driven by the cycle and the cycle at the moment is in favour of financials, so you could almost buy all of them. But every now and then you come across a Capitec and we think one of them could be OUTsurance, which few investors are aware of. It’s actually now listed under RMI, and that name will change. We met with Herman Bosman as well (RMI’s CEO) and we’ve been adding slowly when they did the unbundling. Barry, maybe one or two sentences on OUTsurance?
Barry de Kock:
I think the investment case there has become a little bit cleaner from RMI’s perspective. Where they’ve unbundled Discovery, Momentum, a number of their asset managers, they’re in the process of selling. And now you’re essentially left with OUTsurance the business, listed under the ticker RMI, I think that will actually change as well in due course. As an underwriter, OUTsurance is exceptionally good. They earn underwriting margins of 10 to 20%, whereas you get Santam, who’s typically targeting 5 to 10%.
What makes OUTsurance unique is that they have got a bit of offshore operations, they’ve grown very well in Australia and New Zealand. We expect them to move to a new market soon, we don’t know where, but the management is, as Kokkie likes to say, constantly looking for ways to grow and to do it prudently. I think it’s an extremely well-run business with very good underwriting margins and we have them in the portfolio and we are looking to add. I think it is something unique, given the corporate restructuring that has happened there, as well.
Ben, I want to turn to you because you look after the global companies within the portfolio. And I know you did go on a trip last week, so how do you feel when you look at the South African management teams and the way these businesses are run here locally vs. the global players? How do you see them positioned and how well are they doing compared to their compatriots overseas?
One of the interesting aspects is, firstly, often we as South Africans are quite negative about South Africa in many aspects. But when you meet these management teams, you realise they can sit in Europe or the US and you wouldn’t think they’re out of place. They come across very well, the businesses are run very well. They’ve really caught up from where my understanding was with the technology, as Kokkie mentioned, with the digitalisation. So, that’s going exceptionally well.
The banks seem to be well run. With the higher inflation, they’ve got higher ROEs than the European banks, but that’s the nature of the beast where they currently trade. Looking at South Africa people would think that the South African banks, with load shedding and the riots, must be almost falling over with bad debts. And when you talk to them, there’s very little pain, relatively. They’re still very well provided due to the regulation as well. It’s very similar when you sit in Europe, then people think about Russia and the oil prices and think the European banks must be falling over. And then when you meet them, they’re also very well provided and they see very little risk in that regard. As with any country and any citizen sitting in that country, we’re often very negative about the things closest to us. When you take a step back and you look from further afield, you can often see it’s a lot different than what you actually think. You realise there’s a lot of positives that come through. Overall, I was quite impressed. We hold the European companies in the Denker Global Financial Fund and due to a lot of different reasons, we don’t have any South African exposure in there. But sitting in these meetings, you can often ask yourself ‘why not?’. Some of these banks probably deserve a spot there, or they could, at the current valuation.
Thanks, Ben. I think that’s an interesting take on everything. Kokkie, you guys have spoken about the regulatory component for a while now. And over the last decade, since 2008, it sounds like the regulator and these organisations have learnt and they’re well positioned.
A lot of the management teams, when we asked them about bad debts and the higher inflation environment, all started back at 2008. You’ve got to first understand what happened in the Global Financial Crisis and what the regulator has done since then. Although, I see the European banks are starting to fight with the regulators, saying ‘you guys are just overdoing it now’. But they have protected the system and I think that’s why globally we’re going to be very positively surprised on the lower bad debts because the banks have been forced to be more risk-averse.
But one thing not to be ignored is that we’re most likely going into a global recession. We don’t know how deep, but there will probably a recession. But the positive this time is that the banking and the insurance system is strong and healthy, so you’re not going to have, as the recession deepens, the banks not being able to lend as we had in 2008. I think that will ensure that the recession won’t be too deep, because your financial system is strong and healthy.
I think that brings us nicely to a point which is always nice to ask you guys, what do you feel is the outlook going forward? You’ve highlighted the work you’ve been doing in the last week or two, the meetings you’ve had have been South African focussed – and thank you to you and the team for giving us some feedback there. Investors can access that capability through the Nedgroup Investment Financials Fund or, as you say, there’s a local financials weighting in the Denker local equity funds. Going forward into next year, you’ve mentioned it’s going to be a challenging year. But where the valuation is right now, whether it be ZAR where these funds are positioned, what do you see?
Everybody agrees it will be a tough year globally. Not maybe so much in countries like India and Indonesia, that have come through Covid quite well and have also been quite early, India specifically, in raising interest rates and where the growth rates are strong (in a country like Georgia). Those are three countries we hold in the Denker Global Financial Fund, which have actually helped the fund a lot in this last quarter. Then if you look at the US, growth continues, however it’s slowing down but I think the key is just the valuations.
Then a point, which I keep forgetting with my banking background, is the contribution of the P&C (property and casualty insurance) sector in the Denker Global Financial Fund, which is more than 20%. There Barry’s call has come through very nicely in the last quarter, those of you who had watched the fund will have seen that this quarter to date, it’s sticking up and it’s maybe the P&C shares that have reported very good results, and the European banks. It’s very well positioned, that momentum to continue. So, although it’s going to be a tough year, we’re actually very excited about the fund from the valuations where they are and the earnings momentum of the holdings.
Thanks guys. I really appreciate your time this morning and throughout the course of the year. Best of luck closing out the year. Enjoy your summer holidays and we’ll see you back in January.
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