Junk makes banks a bargain buy

The logos of three of South Africa's four biggest banks - Absa, Standard Bank and First National Bank - adorn buildings in Cape Town. Picture: Mike Hutchings

The logos of three of South Africa's four biggest banks - Absa, Standard Bank and First National Bank - adorn buildings in Cape Town. Picture: Mike Hutchings

Published Apr 13, 2017

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Johannesburg - Foreign investors have been snapping up

South African banking stocks, enticed by the cheapest valuations relative to

emerging-market peers since 2011, even as the country’s downgrade to junk

deepened a broad equity selloff.

Offshore investors bought a net R1.5 billion of bank

shares, including those of FirstRand and Barclays Africa Group, in the six days

after S&P Global Ratings downgraded the South Africa’s foreign currency

debt on April 3. Fitch Ratings followed with a similar cut on April 7,

described by a banking industry body as “ devastating” for lenders. Excluding

bank shares, foreigners sold a net R2 billion of other stocks in the same

period, bringing equity outflows this year to R43.8 billion, according to JSE

data.

Valuations of the country’s banks have plunged to 10

times historical earnings, compared with 19 for the benchmark FTSE/JSE All

Share Index. While facing higher costs of capital, rising bad debts and a

slowdown in lending, banks are well capitalized to withstand the storm and

cheap enough to be bargains, said Adrian Cloete, an analyst at PSG Wealth in

Cape Town.

“Banking shares are looking interesting from a valuation

perspective,” Cloete said by email. “The current almost-50 percent discount is

very large compared to the long term trading history” and the lenders are

offering “very attractive dividend yields,” he said.

South Africa’s four biggest banks were profitable through

the global financial crisis of 2008 and the country’s recession a year later.

With the lenders better capitalised now than they were then, surveys compiled

by Bloomberg show analysts expect them to remain profitable despite the

downgrades and President Jacob Zuma’s firing of Finance Minister Pravin Gordhan

in March.

Read also:  S&P downgrades SA banks

Banks have been preparing for the downgrades, and even

Gordhan’s removal, since Zuma roiled markets when he fired former Finance

Minister Nhlanhla Nene in December 2015, said Neelash Hansjee, banks analyst at

Old Mutual in Cape Town.

Still at risk

Still, South Africa remains at risk of further downgrades

and the political situation is far from stable. Opposition parties marched on

Wednesday to call for Zuma’s ouster, and Parliament may debate a motion of no

confidence in the president pending the conclusion of an application to

the country’s top court seeking a secret ballot.

In the days after S&P’s rating downgrade the rand,

which had been the world’s best-performing currency in 2017, gave up the year’s

gains while bond yields spiked, increasing the banks’ cost of capital. That

means investing in banks right now may be risky, though cheap.

Not all investors are convinced. Policy uncertainty will

continue to weigh on South African assets, said John Ashbourne, a London-based

economist for Africa at Capital Economics Ltd. The ruling African National

Congress is holding a policy conference in June after Zuma promised “radical

economic transformation” following Gordhan’s dismissal.

“I don’t see any silver lining for the nation’s

banks,” Ashbourne said. “We’re waiting for the policy conference in June for

any signs of changes in the nation’s tax and spending policy. Before that

happens, there’s way too much uncertainty.”

The hardest hit bank share this year is Barclays Africa,

which has to contend not only with strife in its home market, but also its parent

company’s planned sale of stock. The six-member banks index has slumped 6.3

percent since the first downgrade, compared with a 3.1 percent gain in the

164-member All Share Index. The bank gauge is the worst-performing index in

South Africa this year and by the end of March had suffered its poorest first

quarter in eight years.

That shouldn’t deter bargain hunters, PSG’s Cloete said.

“The bottom line is that South African banks’ balance

sheets and capital ratios are very healthy, which should be very comforting to

investors,” he said. “They are very profitable with high returns on equity.”

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