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Capitec growth slowing, prodding re-assessment of stellar share rating.

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South Africa’s wonder bank Capitec kept steaming ahead in the six months to end August, but even for its army of fans, warning signs are emerging. The rate of growth in both earnings and dividends are down a few percentage points and off its now higher base, the current 17% rate of expansion is going to be tough to maintain. Overlay the entrance of two powerful new competitors (Discovery and Australia’s Commonwealth Bank) and Capitec’s execs have their hands full right now. Forthright as ever, CEO Gerrie Fourie talks about those challenges in this interview, but stays away from commenting on the stellar rating investors give Capitec shares which now trade at more than seven times book value (up from an already lofty 5.4 times a year ago). Fourie says he never thinks about the share price or the rating of the stock. Just as well. Even Capitec cannot defy gravity indefinitely. – Alec Hogg

Talking to us from Johannesburg is Gerrie Fourie, the chief executive of Capitec. Results out today, Gerrie, it’s interesting to note that even Capitec cannot defy gravity indefinitely, and I say this because a year ago your headline earnings per share were up 19%, this 6-month period 17% (a little bit down), dividends were up 20% a year ago, now they’re up 17% for this first half. Is the world finally catching up to you?

Alec, yes, I think 2 things. If you look at the base that we’re growing from. The basis on the year is much bigger. I’ve just looked at the last 4 – 5 years performance and we’re increasing every 6 months our earnings of about R300m – R400m but suddenly it’s a different percentage, if you’re talking from a R1bn to a R2bn so that’s the one reason. Yes, it’s not that easy in SA. If you look at the SA environment there’s 2 sides. The one is, on the banking side, it’s going extremely well and we’re still growing. We’re picking up client numbers of over 100 thousand. Then on the credit side you need to be conservative giving what’s happening in the economy. I think the economy is in a little bit of a better state than last year this time but still, we’ve grown our credit side 10% overall. I don’t think that’s too bad given what’s happening in SA.

Let’s just dwell a little bit on the credit side because you did talk about reducing interest rates. Unsecured lending now at 12.9%, that’s very much close to what you’d pay on secured lending, and the growth in the interest that you earned was a lot lower than the growth in the interest that you paid. So, that crocodile gap as it were, it does seem to be going in the wrong way for a change.

You must be very careful when you look at the interest because until May 2016, our credit life was included in our interest. From May 2016, it’s actually been excluded and it is shown separate and we’ve also moved the initiation fee into the interest line, regulatory requirements forced us to do that. So, if you look at interest/income the best is actually to look at everything in totality and then you’ll see there’s a 10% growth because of the mix-it that I’m talking about.

All right, I understand and that would also explain why your net loan fee income went from R97m – R640m, which was another exception in the accounts.

Yes, remember up until May 2016, like I said, credit life – we never charged separately for that. That was included in our interest fee or in our interest rate, and then last year we split it to make certain that we were already with the new regulations that came into effect from August 2017. That’s why you need to be very careful and rather look at everything in totality.

Okay, I got that but it still doesn’t explain why you are now charging a very attractive interest rate, 12.9% on unsecured lending. There would be some who would say, ‘hang on a minute, with the big write-offs that you have on that side of your book relative to banks who specialise in secured lending, are you not taking too much of a risk?’

Well remember, it’s not applicable to all our clients and it’s also applicable for our top end clients when they go shorter so, when they go for a 12 month loan or a 24 month loan they get it at a lower price. What we’ve done is where our competitors normally work in buckets, 12, 24, 36, etc. What we’ve done is we’ve created 84 loans meaning that you will have a 23, 24, 25, and a 26 month loan. Each one of those are priced according to risk and priced for the client. The opportunity there is now the client will maybe qualify for an 84 month loan but he wants to buy a TV and he wants to repay it over 24 months, and he’ll choose then the 24 month product, which will be priced at a much lower price because it’s a much shorter term.

All we’ve done is we’ve looked at the needs of the client and made certain that we sell the credit that’s in line with the needs of the client, and I think that’s a big milestone. We’ve said in previous interviews that I said we would like to reduce pricing in unsecured. We’re operating at about 85% – 90% of our pricing is below the caps and we’ll continuously, as we see there’s opportunities, reduce prices. We’ve reduced these prices now overall, in our overall book, worth about 1.5%, that was done in August and that’s making certain that, I think unsecured – given how young it is and how it’s actually developed overtime, we need to bring it much closer to secure it. This is the first phase for us to going closer to that particular market.

Is it also a function of competition?

No, I think if you look at competition we’ve always said, ‘we welcome the affordability guidelines.’ That came into effect and then we always said that, ‘credit life was one area that people took on too much at a risk.’ The new regulations came out – unfortunately, the way the regulations have been written, it’s been written in a way that you can ask credit life either on declining or on the initial capital that the person borrowed. Now, there’s unfortunately still a lot of people that’s still going on initial capital, and they’re making too much profit out of this. All I’m trying to say is that with all the changes in the credit market it brings more stability. If you bring stability you can score your client better and, very importantly, is the fact that we get a big portion, (80% of our clients) that borrows from us are banking clients so, we understand them better. We understand how they transact and what they’re doing and we’re using that to actually say, ‘what is the best credit line in the long term?’

It’s also, in that line, reducing your credit card fee, as you’re saying to your accounts, to R35 a month. Just explain that and why you decided that?

Remember, when we launched the credit card last year in November, we received some criticism to say but your passing is too high. The market expected that we’d be lower. We said then that we will start off with R50 and that we will evaluate the market and make certain that we understand the credit card. We launched the credit card in October 2016, we’ve got close to 200 thousand clients now on the credit card. We’ve got a book of R1.3bn. We’ve got a year’s performance now on that credit card and we’ve delivered on our promise, where we said, ‘we’ll reduce prices to where we think it’s acceptable.’ We’ve reduced it to R35. According to us, we’re the lowest in the market. There is one or two players that is at R25 but then they ask a fee of R15 or R20 on top of that (a service fee). We look at the admin fee as the monthly fee as one fee. They will differentiate it and bring in 2 fees so, it’s in line with our whole pricing philosophy. For us it’s very important to look at what is best for the client and to build a very long term relationship with a client.

TYME, which is owned by Commonwealth Bank of Australia, is near to winning a banking licence in South Africa.
TYME, which is owned by Commonwealth Bank of Australia, is near to winning a banking licence in South Africa.

Operating expenses are covered 76% now by transaction revenue so, that’s clearly a big focus area for you but I’ve been talking a lot about competition and I say this because we have Discovery who are coming into the game very soon, and tomorrow the Commonwealth Bank of Australia, with a market cap equivalent to the top 5 banks in SA combined. They are launching a digital bank in SA. It looks like this space is heating up?

Yes, for sure, there’s competition coming into SA. It will be interesting to see where Discovery is pitching it. Are they pitching it middle-high or only high? We know they’ve got 2.4m clients on Discovery or Vitality so, it’s going to be interesting to see what they’re doing. Are they going to compete with your Investec and the likes of that? Comm.Bank is a different situation, one would have to see what they’re doing. Currently what they’ve tested in SA is pure money transfer and very limited transactions so, it’s still very young for us or very early days for us to say exactly what they’re going to do but yes, there is competition. I think competition is good. I think the very important thing for us is to focus on our fundamentals and deliver on our promise.

Well, competition is good when you’re not rated as highly as Capitec is. In the last year your price to book has gone from 5.5 times to over 7 times. The market or the investors are expecting you to fly to the moon and back on that kind of a rating. Does it make you nervous?

Yes, I think it always makes you nervous because you need to ask yourself, ‘is the share price too high, yes or no?’ But it’s interesting if I look at our exco meetings and we had a board meeting yesterday – we hardly ever talk about the share price. For us, it always goes about the fundamentals, the input, is that correct, and that’s what we’re focussing on? Yes, it’s a bit of a concern but for us it’s more importantly, again, we’re looking at the long term and say, ‘are our fundamentals, right? Are we reading the client correctly and is our product offer correct?’ So, that’s what we focus on.

That, I guess, would be aligned with an ability to continue growing your market share. We always have this conversation, where are you right now, as far as your runway is concerned?

Well, it’s interesting. You’ll see it tomorrow on my analyst presentation. I just asked the question, ‘where can you go into Africa?’ There’s 55 million people in SA, and what is quite interesting is there is 17 million people below the age of 14. There’s 5 million between 14 and 20, and then between 20 and 40, there’s about 24 million and the rest is older. We’ve got about a 27% market share in the 20 – 40. We believe we can take that up to above 35%, and I’m not looking at banking now – I’m just looking at total clients. Then you will always have that potential of people below 20 that you still need to capture and we’ve got a very small market share there. So, we believe, again, there’s runway but the interesting thing on runway is what alternatives there are in SA? There’s insurance, and we are looking at that insurance market. There’s the informal sector – I believe there are long term things to look at there, and there’s even business banking, and then there’s the international side. We believe there’s still runway and there’s still opportunities but the important part is to focus on what we’re doing now and doing it well.

You’ve mentioned the informal sector and 17 million people below 14. There’s also 17 million people who get social grants and a lot of opportunity there. Have you considered making a play for the social grants, given that the incumbent, Net1, is not very popular with government right now?

No, we’ve never thought about social grants and to do that pay out. We see a lot of those clients coming into our particular area, into our branches and what we see is normally ‘cash in and cash-out.’ It’s a client that actually doesn’t transact and doesn’t use your banking facilities, they just withdraw the money. From that perspective we’ve always stayed away from it because we would like to see clients to actively use their bank accounts, and that’s the market we focus on.

So, it’s a different side of the market then. Although, you would go into the informal sector, social grants is not really your target?

No, it’s definitely not a target. The informal market is actually, if you look at SA and you’re sitting with an unemployment figure of 27%, but what is interesting is that the employment number is around about 15 million so, there’s not a lot of jobs that’ve been created in SA. Yet, if you look at what is happening you still see growth if you go into the townships, etc. You see a lot of people are busy with some sort of activity and I believe one needs to create an opportunity for those people to get access to credit and to transact, and to really unlock the full potential of the informal market. It’s not an easy market and it’s probably more 4, 5, or 6 years from now but if you look typically at SA and internationally, nobody has really cracked that particular market because to provide credit in that market you need data, you need to understand how the guys transact and that information is not always readily available because unfortunately, 90% of those transactions are performed in cash so, you haven’t got any data on that.

You mention the international market. You’ve made your first fore there. How’s that going?

Yes, we’re quite happy with that. It’s still very early days. I think we’re going into a phase where we’re looking at how do you build a brand? You look at your pricing and your credit models so, we had one or two strategic sessions but we’re fairly happy. The one thing we’ve seen is if you start operating in the international market you understand the differences between all the regulators in the different countries, and what is happening in those particular areas.

Also read: Disruptive Capitec heads overseas – lays out  €21m on maiden venture

Yes, and Africa?

No, Africa, we’re still not in and it’s currently not on the radar.

Well, let’s hope that changes in the future. Gerrie Fourie, good talking with you, as always, and I hope you don’t lose too many sleepless nights over that 7 times price the book value but so far so good. Just to close off with, there was quite a lot of noise about the fact that your market cap has surpassed that of Nedbank so, it’s no longer the old big 4. It’s certainly a new big 4, with you taking that position. Is that on your radar? Is it to be one of the big 2 or big 3 at some point in the future?

That’s interesting, Alec. We never look at it from that point of view. There’s a lot of noise about we’re number 2 on clients, or we’re number 3 on market cap. It really is never an objective or something that we discuss. For us, it’s purely about satisfying a client and make certain that we can support the clients and make certain we deliver the service with them, so that’s where our focus is.

Gerrie Fourie is the CEO of Capitec.

From Capitec:

Capitec Bank – grew headline earnings to R2.05 billion (August 2016: R1.75 billion) for the current six month period despite applying a stricter granting strategy. By the end of August 2017, Capitec had 9.2 million active clients and increased their number of branches to 811. This represents client growth of 106,000 per month over the last 12 months.

This was revealed in a strong set of interim results to 31 August 2017. Capitec Bank CEO Gerrie Fourie says: “We have evolved our product solutions towards more personalised offerings for clients. In line with this, we’ve changed our credit offering by lowering both interest rates and credit card fees to bring the cost of unsecured credit more in line with that of secured credit.”

He said the continued brand acceptance resulted in a 29% increase in retail deposits and transactional growth for the current period.  “Our service has become more accessible via self-service banking options such as cellphone banking app, internet banking, self-service terminals and dual note recyclers. During this period, we increased our number of self-service transactions by 43%. Additionally, 95% of our clients wait less than 15 minutes for service in branch with the average waiting period only 1 minute, 46 seconds.

Also read: Disruptive Capitec knocks Nedbank off Big Four ‘market cap’ perch

“The value we generate for our clients through personal service and delivery of affordable, accessible financial solutions, drives the growth of our company. Investing in our people and infrastructure supports this growth and allows us the opportunity to create jobs, stimulate the economy and ultimately transform the country in which we live.”

At the end of the trading period, the bank employed 13,532 people (August 2016: 12,479) and had created 1,053 new jobs.”

Gerrie Fourie, CEO, Capitec

Turning to the numbers, Fourie said as well as the strong headline earnings, the return on shareholders’ equity for the current period was 26%. Loan revenue, in-line with loan book growth increased by 10%. Loans and advances in an arrears and rescheduled status decreased by 14% while the net loan impairment expense increased by 8%. Net transaction income increased by 29% in the current six month period and operating expenses increased by 20% in support of the bank’s growth initiatives.

Capitec unveiled a new credit solution in June 2017. “We were able to use our processes and systems to achieve better interest rate options from as low as 12.9% per annum for our clients on our fixed term credit products. The interest rates in this solution are competitive with secured credit market rates.” Said Fourie. The bank also reduced the monthly fee on its credit card to R35 per month.

Also noteworthy:

  • Retained a strong capital adequacy ratio of 35%.
  • Resilient credit rating – Capitec’s global long term credit ratings of BB+ was not downgraded along with the sovereign and other South African banks earlier this year. This means that Capitec is now rated the same as the sovereign and the other South African banks. S&P Global recalibrated Capitec’s national scale ratings after the sovereign was downgraded, resulting in the national scale long-term ratings increasing with three notches from the beginning of the year to zaAA.
  • Net transaction fee income covered 76% of operating expenses (August 2016: 70%) and contributed 40% to net income (August 2016: 37%).
  • Capitec was placed first in the overall mobile banking category by the SITEisfaction® 2017 survey. The simplicity and great user experience of their internet and mobile banking app resulted in Capitec being voted best digital bank of 2017.
  • Capitec was recognised as the fastest growing brand in South Africa and best bank in the world by Lafferty Group for the second consecutive time during the period.

For the full interim results presentation visit www.capitecbank.co.za.

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