Feedback on some of SA’s largest financial institutions

Introduction

0:00Welcome to the Denker Capital Podcast, where our highly experienced team of in-depth thinkers and other experts share their insights on a range of investment-related topics. In this podcast, we have conversations about developments in South African and global markets and what these may mean for investors. We analyze specific stocks and sectors and explore general themes relating to the fundamental principles that underpin sound investment decisions in an ever-changing world.

South African Banks

0:34The Denker Capital Financials team recently met with the management teams of some of the South African banks and insurers. Today is the 9th of November 2022, and 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. Koki, morning. Nice to see you. Thanks for spending some time with me this morning. We've got a full squad here, joined also with Barry, Craig and Ben. Let's get straight into things. You guys have been on the road in South Africa in the last week or so. For the benefit of the listeners, in terms of

1:11common threads and things you've noticed in the market, the feedback that you've had, but really in terms of stocks that you hold in, I mean, in SA would be the Net Group Investments Financials Fund. That would be how people would access your capability here. What have you been, you know, what are you really positive about? What have you been adding to? Maybe you could go around the team and give us some real feedback. No, thanks, Nigel. It was actually quite a good week and a half. We managed to see 10 CEOs, CFOs of all the major banks and some of the insurers as well. And doing it in such a short space of time was actually quite nice because you really get a picture and you ask them the same questions.

1:53We weren't concerned about the next quarter's results, but more the strategic direction as to where they are going to go. And 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 found that an hour had been set aside and after an hour and a half, the CEO said, oh, I forgot, my next meeting has been waiting. Yeah, and it shows it was really relaxed, but more strategy. And the guys like talking about that. So if you ask what are the key things that struck us, what really struck us in these meetings was firstly that 20 years is going to be a tough year, but most important that nobody was really concerned.

2:38Concerned that you've got any risk to the business or risk to the economy. And 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 stocks, were just making it in the end fell over. So the system is a lot stronger and businesses have adapted. Everybody's running lower debt, more higher stock levels, operationally cleaner.

3:08So I think that is the key. I think the big surprise, 23 and 24 is going to be how well the banks and the insurers are going to come through this with low, bad debts in terms of very well provisioned, very cautious in lending. The second thing to me was that digitalization, the effect of that. They've all spent a lot of money on digitizing their businesses, as they call it, end-to-end refreshment.

3:38So, yeah, there's manual systems and the labor-intensive systems have been taken out. Craig can tell you a bit about the big battle they still have with cash. They're trying to get cash out of the system because cash is very expensive. And then I think what differentiated us is the culture, guys like EPSA and Firstrand and obviously Capitec, very strong on the culture. They're trying to generate in the business that people feel like owners, employees feel like owners.

4:12And the last one, and I'll maybe ask each of the analysts quickly to comment on that, is just on the growth strategies because the growth strategies are quite different in terms of where they want to take market share. Yeah, I think that's a great place to go, actually, in terms of what will interest the listener here.

Growth Strategies

4:29And maybe you could kick off and go around the team in the various areas and just talk and highlight some of those businesses that have, you know, really interesting growth strategies. Yeah, I think let's ask Craig first on Standard Bank. Standard Bank always was called the big gorilla because they were the biggest. And they faltered a bit on the technology front and we had very good meetings there and obviously they're addressing that. But what differentiates them is where they will grow and maybe Craig can give more insight on that.

5:01Yeah, thanks, Corky. What came out from the meetings is that if you want to focus maybe 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. And Standard Bank comes to mind, as Corky mentions, where they are 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.

5:33There 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 and that. 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. If you then move on to the likes of ABSA, they're following a similar approach to Standard Bank, maybe not as exposed to Africa.

6:06But they certainly feel that, 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, who does face some challenges. But ABSA believe that if they remain focused and disciplined, as Corky alluded to earlier, with the separation of Barclays having taken place, that this is really a key engine for growth for them. So, they do think at the same time, there's lots to do in their home market here in South Africa. And just touching on culture a bit quickly, you know, ABSA strikes me as a sports team that's winning it all the time and is on a real roll because of how high confidence is.

6:47And that culture that's kind of permeated through the staff and the organization is really playing out and they're doing some great things. And we really like what they're doing there at the moment. It is one of our larger holdings in the Ned Group Fund you alluded to, Nigel. It's of the banks. It's actually our second largest exposure after First Rand, 12% of the fund. First Rand is 16% of the fund. And, you know, what came through from Alan Pullinger, the CEO there, is that they're very committed to the South African story. They do have the UK growth story as well in Aldermore and the Motonova business that sits under Aldermore in the UK.

7:21But 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 kind of like the elephant in South Africa where they can't really maneuver too quickly, but they're really good at what they do. Whereas in the UK, they're more like, say, the mouse where they can be a bit more agile and nimble and take some market share here and there. Cheetah might be more. Cheetah might be more appropriate.

7:52Thanks, Bookie. And then there's Nedbank. Nedbank, you know, has faced some challenges over the years with its Nigerian or Western African exposure and Echobank or ETI. Some people might know it. It is exposed to some very cyclical markets there and they are fully committed. And it is slightly different to the likes of Standard Bank and ABSA where it's kind of a focused 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's some exciting prospects ahead for them.

8:27And then maybe just touching outside the top four, Investec, which we also have quite high exposure to. It's close to 10% now in the Ned Group 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, you know, the word focus and discipline comes up. These management teams are very committed in terms of how they go about capital allocation decisions and determining growth strategies. And then Capitec here in South Africa, you know, similar to first-round South Africa focused, but really playing in a different market, trying to attack incumbents in the banking space and in the insurance space now.

9:08You know, we're watching them, you know, very closely at the moment and excited about what they're doing. So, you know, that's how I run through them from a growth point of view. Nigel, maybe important to point out also for listeners, obviously, these holdings are in the SA Equity Fund as well. And, in fact, all the DENCA funds reflect the views of the team. So, I mean, that's important. So, when we like apps for, let's say, the Ned Group Fund, which we manage, the DENCA funds will add that as well.

9:39And that's why I think important for Barry, the insurance stock that we've been adding to has actually been the old Momentum, Momentum, Metropolitan, MMI, Barry, haven't you? Yeah, sure, Corky. Thanks. So, I think to follow on some of your opening comments on culture and focus, I think Momentum has, certainly over the last few years since the current management took over, changed their focus from being internally focused and fixing a number of internal issues in the business to now sort of having sorted that out and being output focused, looking at market share again, looking at where they can grow and looking at how they can, to quote one of Corky's favorite phrases, be on the front foot.

10:19I think some of our key takeaways from the meeting is that, firstly, for the sector in general, but for the business specifically, higher interest rates and a steeper yield curve is good for the business. And as you can imagine, over the years, the businesses 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-generated business. So, it's a stable business and the yield on the dividend is 7.5%. So, there, you have quite a nice sort of support to your investment given that yield.

10:50Sure. And I think 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 markets in that they've partnered with a very strong health insurance partner in India called Aditya Burla. So, that business has been growing exceptionally fast into a very underpenetrated, very big market in India. And just to give you a sense, they target, over the next couple of years, 40% growth in premiums per year.

11:22They've recently got a third partner join, the Abu Dhabi Investment Authority, who injected a bunch of capital into the business, which has, A, reduces the capital strain that Momentum has to now or would have had to put into the business to continue to grow. And 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. So, a lot of upside there over the long term, provided they can execute, and we think they will.

11:52I think the last point I'd make is that another exciting part of Momentum is guard risk. That is the non-life business, part of one of the non-life businesses within the group, which is slowly taking on more underwriting risk into a very attractive underwriting environment. So, we think there there's a lot of opportunity for growth and success. And again, management has a very measured approach to these things, to grow well and to grow profitably. And then again, lastly, to finish off, we think the shares are extremely attractively valued.

12:23I mentioned the dividend yield earlier, but to give you another sense, the shares are trading at around 17 Rand today. And the embedded value of the shares of 29 Rand and 70, and that's as per management's calculations. And I think there's still a lot of way to go to close that discount. Maybe an important point is that both globally and in South Africa, one of our key focuses always to find undiscovered gems. You know, to find those companies that can outgrow the market for 10 years.

12:55Generally, I mean, the stocks we mentioned tend to be driven by the cycle and the cycle at the moment is in favor of financial. So, you could almost buy the whole, you know, all of them. But every now and then you come across a capitech 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 Alan Bosman as well. We've been adding slowly when they did that bonding, maybe two sentences on outsurance.

13:26Yeah, I think the investment case has become a little bit cleaner from RMI's perspective where they have unbundled discovery, momentum, a number of the asset managers they're in the process of selling. And now you're essentially left with outsurance as the business listed under the particular RMI. I think that will actually change as well in due course. And as an underwriter, outsurance is exceptionally good. So, they earn underwriting margins of sort of 10 to 20 percent, whereas you get Suntang who's typically targeting 5 to 10 percent.

14:00What 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 Koki likes to say, constantly looking for ways to grow and, again, to do it prudently. I think it's an extremely well-run business, very good underwriting margins. And I think, you know, as Koki said, we have it in the portfolio. We are looking to add. I think it is something unique given the corporate restructuring that has happened there as well.

14:33Okay, great. Ben, I might just turn to you because, I mean, you look after the global companies within the portfolio. And I know you did go on the 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 versus the global players? How do you see them positioned? How well are they doing compared to their compatriots overseas? I think one of the interesting aspects is, firstly, often we as South Africans are quite negative about South Africa in many aspects.

15:05But when you meet these management teams, you realize, on that basis, they can sit in Europe with the US and you wouldn't think they're out of place. I mean, 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 Koki mentioned, with the digitalization. So that's going exceptionally well there. And the banks have to be well-run. And, obviously, with the higher inflation, they've got higher ROEs than, you say, the European banks. But, yeah, I mean, that's nature of the beast where they currently trade.

15:37I think the other huge difference or bias we all have is, as I say, when you sit in Africa, we think, even me, who looks at the financial sector in Europe, we think the African banks with load shedding and the riots, they must be almost falling over with bad debts. And when you talk to them, there's very little pain. I mean, relatively, they're still very well provided. It's the regulation as well. And it's very similar when you sit in Europe and people think about Russia and the oil prices and European banks with falling over. And then when you meet them, also, they're very well provided.

16:10They see very little risks in that regard. So I think, yeah, I mean, as any country and any citizen sitting in that country, we're often very negative about the things closest to us, where you take a step back and look from further afield. I think you can often see it's a lot different than you actually think when you actually realize there's a lot of positives that come through. So, yeah, I was overall quite impressed. And, yeah, I mean, we hold the Europeans, obviously, in the global financial fund. And, yeah, just due to a lot of different reasons, we don't have any South African exposure in there.

16:43But sitting at that meeting, you can often see why not. You know, some of these banks should probably deserve a spot there. They could at the current valuation. Okay. Thanks, Ben. I think that's an interesting take on everything. And, you know, Koki, we've spoken, or you guys have spoken, this sort of regulatory component for a while now. And over the last, you know, decade, since 2008, et cetera, you know, it sounds like the regulator and these organizations have learned. Yeah. And they're well positioned. Yeah. I think it's a lot of the managements when we asked them about bad debts and the high inflation environment all started back in 2008.

17:21You'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 for the regulator 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 see, we're very positively surprised on the low, bad debts because the banks are being forced to be more risk averse. Because one thing not to be ignored, we're going into a global recession, most likely.

17:52We don't know how deep, we don't know, but there will be a recession. But the positive first time is that the banking and insurance system is strong and healthy. So you're not going to have, as a recession deepens, the banks not being able to lend as we had in 2008. And I think that will ensure that the recession won't be too deep because your financial system is strong and healthy. Yeah. I think that brings us nicely to a point where, you know, we're approaching the end of the year.

Outlook for Next Year

18:19And as always the case, it's always nice to ask you guys what you feel is the outlook going forward. So, Koki, maybe start with you and you can give us an overview. I mean, as you've highlighted, the work you've been doing in the last week or two, the meetings you've had have been South African focused. And thank you to you and the team for giving us some feedback there. Investors can access that capability through the Net Group Investments Financials Fund. Or as you say, there's obviously a financials, a local financials waiting in the Denka local equity funds.

18:55Going forward into next year, you mentioned it's going to be a challenging year. But where the valuation is right now, where the PEDs are, where these funds are positioned, what do you see? I mean, 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 I've also been quite early, India specific, in raising interest rates and where the growth rates are strong.

19:29A country like Georgia. So, those are three countries who are holding the Global Financial Fund, which have actually helped the fund a lot in this last quarter. And then if you look at the US, growth continues, although it's slowing down. But I think the key is just the valuations. And then, sorry, the point, my banking background, I keep forgetting the contribution of the P&C sector in the fund, which is more than 20%. And their value score has come through very nicely in the last quarter.

20:01Those of you who have watched the fund will have seen that this quarter to date, it's sticking up. And it's mainly the P&C shares that have reported very good results. And the European banks. So, you know, it's a really well position, 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. Guys, I think we'll leave it there. I really appreciate your time this morning and throughout the course of the year.

20:34And for anybody listening, we will have the team out on the road next year, fairly early on in the year, in the various centres. So, keep an eye out for that one. But, guys, thanks. Best of luck closing out the year. Enjoy your summer holidays. And we'll see you back in January time. Okay. Thanks. Thanks. Thanks, Marj.

20:56Thank you for listening to this episode. We hope you found it interesting. If you would like to join us again, please subscribe for more investment insights. To find out more about our team and the funds we offer, please visit our website at denkacapital.com.

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