SA’s Banks, the little issue of unsecured lending; Telkom; Curro and more with Matthew Warren

On the back of contracted GDP figures this week, as well as today’s PPI numbers coming out higher than expected, at 8.8%. It was fitting that Standard Bank also noted an increase in bad debts today. On trend with concerns over the South African consumer market, it seems that all of the pressure-point indicators that we look out for in South Africa’s delicate economy are being pinged. Along with warnings from David Shapiro of tough times for the retail sector in coming months, Mathew Warren of First Avenue Investments, discusses his bearish position on Capitec and the arguably over-extended unsecured lending market. There is good news though, Curro has announced an exciting new investment, and seems to be on a run. Which goes to show that if you follow good entrepreneurs you’re likely to make good investments. Another hot topic has been that of Telkom and its seemingly successful turn-around strategy, Matthew gives some insights into the telecom space and what Telkom must do to defend its market share. -LF 

ALEC HOGG:  Let’s get a more in-depth view of how the market’s trading today.  Matthew Warren is Head of Financials and Retailers at First Avenue Investments.  Twice in two days, Matthew.

GUGULETHU MFUPHI:  You called him ‘too clever’ yesterday.  Are you complaining now, Alec?

ALEC HOGG:  No, I’m saying we’re graced with your presence, but isn’t it an interesting at Apple.  We just heard Sifiso say it’s a R3bn transaction.  Apple’s market cap is R537bn, so it’s just over half-a-percent of the market cap, yet it’s the biggest deal Apple’s ever done.  It tells you something about the whole philosophy of the company and how you can grow a company without having to make acquisitions.

MATTHEW WARREN:  Yes, the organic growth inside Apple in the last decade is phenomenal, creating new products, new categories, and the whole ecosystem in IOS in terms of apps and music.  Many high-end consumers around the globe have moved to Apple products and they’re storing everything there, so there’s a stickiness there.  Whether the device sells might go in cycles, bargains might come off over time unless they invent something new, but they’ve created a franchise there and it’s pretty impressive.

ALEC HOGG:  Not many big companies have done as few takeovers as Apple has, which again tells you they’ve been massively successful.  Maybe we’re a little too eager – or corporates are a little too eager – with their M & A.

MATTHEW WARREN:  Yes, I think that can be the case.  A lot of M & A goes wrong.  It could be worrying because the concern in Apple is that Steve Jobs is no longer there, so even more corporate-type manager now…  Can they come up with the next big product to fold into this ecosystem?  Maybe, if they struggle with that, are they going to change strategies and doing more M & A?  I don’t think it would be very encouraging.

ALEC HOGG:  Do you own shares?

MATTHEW WARREN:  No, we don’t.

ALEC HOGG:  Okay.  My favourite – and Gugu was very kind to remind everybody that I like Telkom – and it isn’t necessarily because of any other reason, than it’s really cheap, good value, and a good team.  Good managers are in there at last.  What’s your view on it?  The share price is up nicely today on that trading statement.

MATTHEW WARREN:  I think you’re right in terms of management, it’s gotten better, and so government took a bit of a step back.  They brought in new board members – a new CEO, obviously – and they seem to be going in a different direction.  They’re not going to pour so much money into mobiles where they’re coming from nowhere and trying to form a position.  Maybe that black hole of cash flow is gone or diminishing.  They wrote off a lot of historical assets, so the P & L is rather flattered by this huge write-down that they took.  You have to keep that in mind.  I think the problem really is that the mobile operators in Internet access are actually beating them.  DSl should win out a large share with the best product and really, the mobile product can be better here in South Africa, and I think that’s a key issue, which needs to be addressed on the retail side of things.

GUGULETHU MFUPHI:  There were also some interesting movements on the technology front.  I know Nadim is the resident expert at First Avenue, but with Telkom and the BCX acquisition, and Vodacom with Neotel…  When you look at those two in particular as investments, do you favour one of them more?

MATTHEW WARREN:  We actually own nothing in telecommunications right now, and that’s been the case for a while.  Nadim’s thesis, which is playing out…  He was speaking in the market long before we saw the price war kick in, and he was talking about that quite some time ago, so kudos to him.  We’ve really seen that step up.  Cell C has brought the battle to the other players and they’ve done it without the regulator, in terms of lower MTR’s and asymmetry.  They’re at a critical juncture.  They really need to scale up and improve their cash flow so they don’t have to keep taking on new capital, which they’ve done for a long time.  If they can get through this period and scale up, we might actually have a competitive type of mobile phone industry here in South Africa, which would be great for the consumer.

ALEC HOGG:  Telkom however, getting back to that one, Nadim hasn’t changed his mind since the deal Gugu mentioned with BCX.

MATTHEW WARREN:  No, I think they’re trying to entrench their position.  Corporate is really where they’re strongest at this stage, and they need to defend that position at all costs.  We’ve seen MTN and Vodacom come in and snipe some business there.  You have to have the fibre network for back home, and they’ve used that to get client accounts on the business side of things, so Telkom really needs to defend that.  They need to be the best provider there.

ALEC HOGG:  Curro isn’t a stock that everybody follows.  It’s very highly rated.  The share price is up again today on a voluntary announcement.  Do you follow it?

MATTHEW WARREN:  We follow it.  We screen it for style and quality, over track record, so nascent quality for us would be demonstrating great financials for a course of three years and then most in our universe would be eight years of very solid financial performance.  They might get there.  You can see they’re addressing a market opportunity that’s there.  They seem to be doing it in a clever fashion, so we’re following it in anticipation that they might come into our investment universe down the road.

ALEC HOGG:  You have to look at the man behind it all – Jannie Mouton – because he’s done it time and time again.  He did it with PSG, the firm he’s at the centre of, he clearly supported Capitec when nobody else was really interested, and now he’s putting a lot of effort behind Curro.  Maybe sometimes, when one follows an entrepreneur, that’s the way to really make proper return on investments.

MATTHEW WARREN:  I wouldn’t argue with that.  My favourite example in the world that I find inspirational is Elon Musk – a South African, actually.  In terms of being an industrialist and an entrepreneurial industrialist, what he’s done in the States is phenomenal.  He’s creating new industries and he’s doing it in a financially successful fashion.  The more that happens in an economy, the more vibrant it is, the better the growth will be, there’ll be more job opportunities and leadership.  On the example you’re mentioning, the more that’s done here is the same fashion.  If Curro is very successful, it’s going to be a building block for better things in the country, so it is exciting.

GUGULETHU MFUPHI:  One wonders, because we don’t have that type of leadership in the banking sphere, which leads us onto Standard Bank, where they’re again raising red flags about increased bad debts, which we know will have a ripple effect onto other industries.

MATTHEW WARREN:  Yes, the bad debts started in unsecured, as we know, on the retail side.  They moved into credit cards and auto as well, and that’s a typical cycle.  It’s likely to hit housing at some stage if the cycle continues.  Standard Bank really was one of the more aggressive of the Big Four, so in the unsecured space for example, they really sliced, diced, and changed their reporting so it’s hard to see exactly what they’re doing there.  However, they’ve grown the book at a pretty good clip, they only cut it off at the very lower income portion of the market, and they carried on with unsecured lending.  They’re the most aggressive mortgage lender over the last few years, so if the credit cycle comes, which I think is coming in South Africa, their South African book is going to feel more pressure than it did with the rest of the Big Four.

ALEC HOGG:  What about Capitec?  Have you looked there, given that unsecured lending is an issue?

MATTHEW WARREN:  I’m a notable bear in Capitec and on the space in general.  I wrote a piece back in 2012, talking about things that just went wild in unsecured lending in general.  Even the furniture retailers were jumping into the space.  The Big Four banks followed the rapid growth of African Bank and Capitec.  Capitec’s results have held up better than African Bank clearly, so far, but a big part of the reason for that is that they’ve now trimmed down.  Forty percent of their entire loan book is greater than five years in duration.  I think they’re rescuing their own customers and pushing off the trouble into the future, so that trouble will continue to come.  They just staggered it out a bit more.

GUGULETHU MFUPHI:  But isn’t there a strategy as well, moving into transactional banking work for them perhaps to offset that?

MATTHEW WARREN:  It’s a clear differentiator versus African Bank and it makes their business model stronger than African Bank.  I think with Capitec, it could have been a huge success story.  It was.  I think it could be into the future.  If they pulled back dramatically on lending about two-and-a-half years ago, they would have maintained all….

ALEC HOGG:  If you look at their numbers, their new loans dropped dramatically over that period.

MATTHEW WARREN:  They did it a little later.

ALEC HOGG:  A bit too late in the game.

MATTHEW WARREN:  They were going about the fastest into the peak of the cycle.  Out of all the competitors, they were going about the fastest, right into the peak of the cycle, which is right around the second half of 2012.  After that, they started to pull back, but their book has grown so quickly that the concentration of recent vintage loans in their book is enormous.  It’s a big part of their book, and they continue to roll that, so that vintage carries forward even more, but it’s a lot of recent loans to highly indebted consumers, with longer duration and larger amounts.  The trouble’s going to continue coming through Capitec’s book.

ALEC HOGG:  They argue very differently.  I went to spend a day with them and they argue completely differently.  They showed me the numbers, which tend to suggest that they did see the trouble coming like FNB or First Rand saw it coming in 2007/2008.  Remember, they pulled back when everybody else was going hell-for-leather.  Now they’re in a good situation – at First Rand, that is.

MATTHEW WARREN:  Yes, Barclays didn’t join the party.  Nedbank pulled back pretty early in the game, First Rand after that, and Standard Bank last.  African Bank pulled back and then Capitec pulled back after that, so they pulled back but they’re still growing the book quite rapidly.  They went from 80 percent growth to a lesser, very large growth number in that late innings over the credit cycle in unsecured.  I know they’re selling a different story to their shareholder base.  I disagree.  I think time will tell with this one.

ALEC HOGG:  Well, that’s Matthew Warren from First Avenue, ‘too clever Warren’, as we call him here.  If he were a footballer, we know what his nickname would be.  He’s the Head of Financials and Retailers at First Avenue Investment, and a bear on that side of the table, on Capitec.