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PHANTOM SHARES

The Finance Ghost: You could’ve banked on the banks in 2022

The Finance Ghost: You could’ve banked on the banks in 2022
Illustrative image: Nedbank and Standard Bank, two of the Big Five banks in South Africa. (Photos: Papi Moake/Gallo Images and Waldo Swiegers/Bloomberg via Getty Images)

Both Nedbank and Standard Bank have reported healthy credit levels, contributing to a major improvement in earnings in 2022 vs 2021.

Hindsight is easy, but there was some foresight involved here as well. At the start of 2022 I frequently wrote about the conditions that looked favourable for banking. With inflation driving growth in balance sheets and rising rates leading to a higher cost of debt, the net result could only be growth in both volume and pricing for banks. Just like any other business, an increase in volume and pricing leads to a juicy result.

The worry was around the credit loss ratio, but only Sasfin seems to be in trouble there. Both Nedbank and Standard Bank reported healthy credit levels in the past week, contributing to a major improvement in earnings in 2022 vs 2021.

Return on equity (ROE) is the most important metric in the banking industry, as the balance sheet is mostly carried at fair value, so equity (the difference between assets and liabilities) is an excellent proxy for the extent of shareholder funds in the business.

If the bank’s ROE is higher than the cost of equity, it should trade at a premium to book value (rather than a discount).

Standard Bank’s ROE was 16.4% for the year and Nedbank is at 14.0%, so the latter is running below its cost of equity and the former is running slightly higher. At Absa, this metric is slightly below 17%. FirstRand has been higher than its peers for years now, running at 21.8% in the latest financial period. This is why FirstRand trades at the highest price/book of the big four banks.

But when it comes to price/book, Capitec is the outlier by a huge margin. Typically trading at levels in excess of 5x book when the peer group trades at between 1x and 2x book, a high ROE isn’t enough by itself to justify this valuation for Capitec.

Growth needs to remain high or that multiple is likely to unwind. With headline earnings per share growth of between 13% and 16% expected for the year ended February 2022, I’m not sure that’s enough.

Can you bank on the banks for 2023? Load shedding is the most important variable here, as our banks need economic growth to support their own growth. I don’t think 2023 will be quite as juicy as 2022 in terms of share price performance.

Mpact makes an impression

If South African businesses can be compared to a class of students sweating their way through a pop quiz, then Mpact has to be the annoyingly smug class nerd who always comes prepared. 

Thanks to early investment in renewable energy and a very clever demand curtailment agreement with Eskom, Mpact is weathering the load shedding storm a lot better than most of the economy.

Preparation. Preparation. Preparation. It works.

The proof is in the numbers, with revenue up 7.1% and earnings before interest and taxes having increased by 22.9% thanks to higher average selling prices. There was a 170 basis points improvement in return on capital employed, coming in at 18.5%. 

With the plastics business having reported flat operating profit, it was the (thankfully much larger) paper business that drove this result with growth in operating profit of 26.8%.

To achieve 25.3% growth in headline earnings per share for the year ended December 2022 is a great outcome, particularly with the distraction of the dispute with Caxton & CTP that was playing out at the Takeover Regulation Panel (and over Sens). Mpact seems to have drawn first blood there, with the Takeover Regulation Panel dismissing Caxton’s application and finding in favour of Mpact.

With a total dividend of 115c for the year, Mpact is on a trailing dividend yield of roughly 3.8%.


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An ocean of opportunity, but not everybody knows how to fish 

The only nets that Sea Harvest enjoyed in the year ended December 2022 were the fishing nets, because net profit went the wrong way with a vengeance.

A 27% improvement in revenue was ruined by a gross margin contraction from 31% to 23%. When it comes to volatility, it’s hard to beat primary agriculture.

The fish are still biting, but the cost of getting them out of the water and moving them around has risen spectacularly because of the fuel price and broader supply chain costs.

An impressive effort to cut fixed costs by 9% in the local fishing business wasn’t sufficient to offset the pressure in variable costs.

With Ebit (a proxy for operating profit) down by 25%, Ebit margins dropped from 15% to 9%. When investors talk about a “defensive” stock, this is the exact opposite of what they mean.

Rival I&J also rocked the boat at AVI – and not in a good way. When a company’s narrative focuses on results excluding a particular division, I can almost guarantee that it did very badly. With a 54.9% drop in operating profit at I&J because of fuel costs and an unfavourable abalone sales mix because of Chinese lockdowns, it really wasn’t a great time to go fishing. This was severe enough to drive just a 0.6% increase in headline earnings per share at AVI, despite group revenue increasing by 7.2%.

Speaking of abalone (and oysters in this case), Sea Harvest is increasing its stake in Viking Aquaculture from 54% to 82%. This deal is worth R210 million and there will be five annual instalments to pay for it. Sea Harvest is trying to increase its exposure to higher value seafood products.

It’s too late for coal in your Christmas stocking

Being naughty in 2021 would’ve paid off, as coal was a fantastic investment in 2022. Thungela managed to double its headline earnings per share in 2022, capping off a period for that company that none of its shareholders will ever forget.

But if Santa brought you some coal last year, it was too late. Thungela is down by 40% in the past six months as coal prices have dropped.

Despite reporting such remarkable earnings in 2022, the share price only cares about future earnings. All valuations are forward-looking, but the effect is most visible in commodity stocks and especially single commodity stocks.

Thungela is on a price/earnings multiple of around 1.6x, but that doesn’t make it cheap!

In a nod to a couple of other mining stocks, African Rainbow Minerals increased its headline earnings by 40% for the six months ended December thanks to a strong performance in coal and manganese.

Exxaro grew headline earnings per share by between 20% and 34% in the year ended December, a result that could’ve been so much better if Transnet just worked. DM168

After years in investment banking by The Finance Ghost, his mother’s dire predictions came true: he became a ghost.

This story first appeared in our weekly DM168 newspaper, which is available countrywide for R25.

DM168 11/03 FRONT PAGE

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