FirstRand’s British experiment ended underwater, and at great cost. Back home, however, things are much sunnier. Its South African and broader African franchises are growing strongly, generating returns few banks can match.
Putting aside its UK motor-finance pickle, the bank’s underlying performance is hard to fault. For the year ended June, continuing operations boosted normalised earnings by 13% to R44.5bn, and generated a return on equity of 24.9%.
Lending grew, as did deposits, and credit losses stayed under control. Growth came from both the core lending book and fee-generating activities, with net interest income rising 8% and non-interest revenue increasing by 12%.
Gary Davids, investment analyst at Sanlam Private Wealth says the underlying result was considerably stronger than the headline numbers suggest.
“The UK motor-finance charge was largely a one-off regulatory event that masked what was otherwise a very strong operating performance,” he says.
Still, R17.5bn in provisions for compensation linked to historic UK motor-finance commissions, is a tough pill to swallow. And the ultimate cost remains uncertain; FirstRand itself warns that the eventual bill could still differ materially from its current estimate.
Life after Aldermore
But what remains after Aldermore is sold might present a more encouraging picture.
CEO Mary Vilakazi called the underlying performance “excellent”, pointing to double-digit profit growth from FNB and RMB. “These outcomes reflect the strong topline growth, improved profitability and returns generated by the group’s two largest franchises,” she said on Thursday.
Despite the onslaught of rivals like Capitec, FNB managed to grow normalised earnings by 12%, while its ROE increased to a whopping 40.5%. RMB was helped by investment banking, global markets, and private equity.
Yet Davids cautions against assuming all of that momentum will continue at the same pace.
“Treasury, private equity realisations and market-related revenues can be volatile by nature, so investors should avoid annualising the strongest components of this year’s growth,” he says.
“The more sustainable story remains the steady expansion of transactional and client-driven fee income,” he believes.
But FirstRand’s attraction has never simply been based on one-off bumper years. A large part of the bank’s earnings comes from businesses with entrenched customer relationships, relatively cheap funding and high returns on the capital they consume.
That is also why the impending exit from Aldermore could free it up. While the UK business gave it diversification when FirstRand bought into Britain, it never produced anything close to the returns of the group’s strongest African franchises.
Competitive advantage
“Exiting would simplify the investment case and increase the weighting towards businesses where FirstRand has demonstrated a sustainable competitive advantage,” says Davids.
That’s not to say it was all good news; motor business WesBank produced a 4% fall in normalised earnings, to R2.3bn, despite strong lending growth, while impairments rose 28%. FirstRand attributes this to strain in newer lending, concerns about recoverable vehicle values as new low-cost entrants come into the market, and additional provisions linked to risks from the Middle East conflict.
This hasn’t deterred FirstRand from raising its long-term ROE target for continuing operations to 21%-26%, expecting returns to stay near the top of that range over the medium term.
“Historically, investors may have viewed a 25% ROE as peak-cycle profitability,” says Davids. “Time will determine whether this is fully sustainable, but management’s willingness to raise its long-term target suggests it increasingly views these returns as structural rather than cyclical.”
This has also left FirstRand with some room to reward its shareholders. The group lifted its annual dividend by 16% to 539c, supported by a capital position comfortably above its own target.
The news initially pushed its shares over 4% up on Thursday, but the stock closed only 1.4% ahead. Over one year, however, FirstRand shares have gained 31% and Davids believes that FirstRand’s premium to its local peers is justified.
“FirstRand continues to deliver superior earnings growth, capital generation and, most importantly, returns materially above its cost of capital. This allows the group to create economic value at a rate few peers can match,” he says.
But with much of that quality already recognised by the market, he expects further upside to depend more on continued earnings delivery and capital returns than on investors paying an even richer multiple.
“My biggest concern is not the quality of the franchise itself, but the operating environment,” says Davids. “Weaker economic growth, consumer stress and lower business activity would ultimately constrain loan growth, credit quality and earnings momentum.”
Vilakazi seems unfazed. “FirstRand’s client-facing franchises are healthy and well positioned for ongoing growth, as they have clearly demonstrated this year,” she said.
And with Aldermore out of the picture, the bank will have fewer distractions to detract from that promise.