Capitec’s results unpacked: drop the hype, check the numbers – and be afraid

Capitec has been the JSE’s go-go stock of the past few years. Feeding off a structure which hugely inflated returns on its core business of high priced unsecured loans, the micro-lender has mushroomed into a sizeable banking operation. But the Marikana tragedy last August brought long overdue focus onto practices in unsecured lending. And with it, has threatened the micro-lending business model. Evidence of how this is affecting Capitec was clear in yesterday’s financial results with a 70% surge in writeoffs and a sharp decline in new loans. Even so the stock’s price barely moved. Perhaps shareholders, so well rewarded for so many years, are ignoring the obvious hoping it will go away. This superb analysis contributed by a money manager we’ll call Charlie Graham, highlights the issues shareholders should be focusing on. Capitec is no longer the spectacular business its bombproof share rating suggests. – AH 

By Charlie Graham*

There are three major issues the market has overlooked with regard to Capitec which I think need highlighting :

1.       Capitec has virtually no free float. Although advertised at 40% free float, this is closer to 10% or less of shares. A large portion of shares are tied up by insiders who include PSG and PSG nominee accounts and cross holdings – on the day that its highly influential CEO Riaan Stassen surprisingly resigns, only 66 000 shares traded on the exchange – ie just R13m  turnover.

2.       Capitec rolled a large portion of its book into longer dated loans. In effect this has delayed clients falling into arrears, making their loans more affordable and delaying judgment day. It appears that Capitec is converting existing clients into longer data loans to prevent their loan book from seasoning and keeping arrears levels artificially low. The graph below clearly shows this:

As can be seen above, not only did they increase it, but 40% of the net loan book now resides in the 61 – 84 month category vs. 0% a year ago. This is indeed, very aggressive growth into unchartered territory in a short period of time.

The result of extending the term of the loan book is twofold:

* Loans that appear to be non performing can be consolidated into longer term loans which attempt to rehabilitate non performing clients and mask arrear levels and;

* Arrears are suppressed making provisions look overly conservative.

Graph 2 : Capitec Arrears vs industry peers

The above table speaks for itself, Capitec arrears at 5.5% as at H1 ended August 2013. Either they have reinvented the wheel or the rolling of their book to longer dated loans is masking the deterioration in bad loans.

3.       Capitec is still growing its book at an aggressive pace

Capitec ended February 2012 with gross loans and advances of R18 408m. From 01 March 2012 to 30 September 2012, it advanced R12 831m, a growth in net sales of 39% over the prior year, leaving gross loans and advances of R24 697m at 30 September 2012. From 01 October 2012 to 28 February 2013 Capitec advanced a further R12 570m a growth in net sales of 23.6% over the prior year, leaving gross loans and advances of R30 658m at 28 February 2013.

On a comparable basis from 01 October 2012 to 31 March 2013, African Bank had net sales of R12 542m, a decline in growth of 3.86% over prior year, leaving gross loans and advances of R58 799m at 31 March 2013.

When comparing net sales growth, one needs to compare this relative to their respective book size in order to make a direct comparison. Comparing net sales in absolute term is misleading.

As can be seen in the below graph, when compared relative to Gross Loans and Advances, Capitec is still growing its book at DOUBLE the pace of African Bank.

In yesterday’s results Capitec issued R9.5bn in new loans for the six months ended August 2013. This is still on pace for R20bn per annum in loans advanced – DOUBLE the relative pace of African Bank’s issuance (when taken against current book size ). When this slows down and the tide goes out, you will see that Capitec is the bank swimming without shorts.

One also needs to remember how sensitive these businesses are. All it takes is an increase in provisions from the current level of 9.8% to the industry norm of 15-17% to wipe out all profits and to lose a big chunk of equity.

I want to close with this historic graph of Capitec’s arrears levels…. That makes me go HHMMMMMMM :

 * Charlie Graham is a research analyst at a major money manager. He wants to be able to share his thoughts freely so prefers using a nom de plume.