CPI SJ_A Critique on Credit Risks & ROE_Solid Footing but We Maintain Our HOLD on Valuation Risk

8/7/2019 CPI SJ_A Critique on Credit Risks & ROE_Solid Footing but We Maintain Our HOLD on Valuation Risk

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CAPITEC BANK

Solid footing but rich valuation

Meeting with management affirm our long-termfavourable outlook; we maintain our HOLD, FY12Target price (TP) 17499c: Capitec (CPI SJ) remains a

superior long-term position, in our view, as it remainsfavourably structurally positioned. Management still believethere are significant opportunities in the micro-finance (and

unsecured lending) segment. They do not see considerableheadwinds related to competition and the ConsumerProtection Act (CPA) (and we do as indicated by our

assumptions) although they highlighted that the CPA couldnegatively affect fixed deposits mobilisation as it grantsdepositors the right to terminate their fixed term deposits.

This could increase the cost and sensitivity of banks fundingoperations. The pursuit of lower-cost delivery channels hasbeen constructive to the banks cost base. The strategy ofpartnering with retailers, especially the smaller ones, andthus reduce costs related to branch network continues inorder to attain a high volume-low cost business model.

According to management, the idea is to attain scale suchthat volume (asset rotation) will be more important indetermining the banks profitability than margin. Whilemanagement shows a high level of conviction in their

business model, investors continue to be sceptical ofprobable weakening growth and credit risks yet there waslack of discussion on expected growth due to ambiguity (i.e.

no hard number related to growth of deposits or loans) but

extensive discussion on credit risks.

The share price has been extremely volatile in the past fewweeks. After it declined to 13925c on March 15, 2010 and

our subsequent recommendation change to BUY as thepotential upside ascended to >20%, the share price ralliedmaterially that the opportunity has already disappeared in aspace of


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1. Credit risks: Identifying and

dissecting the fears

Investors are concerned by credit risks but wrongly so: Wenote that investors are concerned by two principal issues 1) creditrisks (hence lower conviction on earnings going forward,warranting the view that the share is expensive; and 2) low level

of external liquidity (of the share). In this report, we focus on theformer as management indicated that they do not pay muchconsideration to the level of the share price but pay considerable

attention to the banks risks. In highlighting what we think are keyissues in credit risk analysis related to Capitec, and our relatively

constructive stance on credit risk (which we discuss below), we arenot implying there is nothing that could go wrong. There are

always unknowns. We identify the following main issues relatedto Capitecs credit risk exposures:

Capitecs provisioning model is conservative...: Capitec hasan extraordinarily conservative provisioning policy. Key to note isthat there are more banks that under-provide than over-provide,mainly because bank managers operate on the assumptions thatprovisions are only triggered by NPLs, except in extra-ordinary

circumstances or when accelerated provision is enforced byregulators. In a period of strong loan growth (i.e. Capitec) thisassumption could prove fatal to future earnings. In our view,

Capitec managements accelerated provision policy shows thatthey understand the nature of their loans (credit risk-wise) and theexpected losses. We concur with management that provisions

should be established for losses expected and not just realised i.e.NPLs. As indicated below, Capitecs provision policy has beenextremely conservative. (see Fig 1). 1) The general provision levelfor Capitec is higher at between 2%-5% vs. a typical range of0.5%-2% for mainstream banks, which is a generally accepted

practice. We believe that given the higher credit risks, highergeneral provisions are worthy; 2) Specific provisions areparticularly aggressive, with loans in arrears by one month and

two months provided for 30% and 60% respectively. Generalindustry practice does not provide for such loans, often referred toas past due loans. NPL recognition often kicks in at 90 days inarrears, at which point Capitec writes off the loan. Generally,acceptable practice would provide for 50% of unsecured loans and

then 100% if the unsecured loan runs to 180 days in arrears. (seeFig 2).

...hence the high loans in arrears coverage ratio: Due to thefact that 1) besides general provisions, specific provision areestablished when loans are not yet classified as NPLs (i.e. +90days in arrears) and 2) loans are written off when they are in

arrears for +90 days, the coverage ratio for Capitec is high. (seeFig 2). Generally investors would be more comfortable with banks


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that have high coverage ratios than otherwise as it reduces NPLoverhang risk to a large extent (i.e. higher earnings visibility and

lower downside risk resulting from future bad debts) as well assupports the quality of earnings. (i.e. current earnings are notinflated by dubious interest accruals as banks generally

discontinue accruing interest when the loan is classified as NPL).The arrears coverage ratio of 135% gives us comfort although thecaveat is that it would tend to be volatile due to performance ofloans in arrears. The more they are written off, the lower the

arrears figure could be and the higher the coverage ratio would be.This is not to undermine the prudence in writing off bad loanswhen they exceed 90 days in arrears. In fact, Capitec effectively

does not recognise the general definition of NPL as it would writeoff at the point it should start making provisions.

Capitecs credit risk has been declining over the past 5years: The loans in arrears/gross loans ratio, which would indicatethe extent to which loans are going bad (rather than the provisionwhich is a largely management estimate figure) has been steadilydeclining since FY07 (11.6%) to FY11 (5.7%). Loans in arrearsgrowth rate has also lagged gross loans and advances growth rate

which is a positive. Loans and advances have expanded by a CAGRof ~86% while loans in arrears have grown by ~60%. Provisionsgrew by a higher rate than loans in arrears at 66%. Given the

short term nature of the loans, a large part could be repaid beforereaching a FY cycle. As a result, management prefers to watch theloan impairment expense/instalment ratio. This ratio has also beenimproving. For 3-month product, the ratio has improved to 1.2%

in FY11 from 1.6% in FY07. The 48-month products ratio has alsoimproved from 50.8% in FY10 to 30.3% in FY11. (see Fig 3). The

banks high provision policy for new loans means that the ratio fornew longer term loans is higher. While this market segment (lowincome and unsecured) is highly risky, Capitec benefits from lowlevels of asset concentration although concentration andcorrelation risks could be noteworthy at clients employer level.

Fig 1: Higher general provisions accelerated specific provisions and write-offs...

Loan status

Capitec's Prov ision

practice

General ly Acceptable

Provision practice

Not in arrears2%-5% as general

provisions0.5% -2% as general provisions

1 month in arrears ~30% no provision

2 months in arrears ~60% no provision3 months in arrears ~98% 50% of balance

> 3 months in arrears write off 100% provision for >180 days

Source: Capitecs general provision policy provided by management, Legae Securities


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Fig 2: ...ensures high er arrears cover age ratios

Rand,mn 2007 2008 2009 2010 2011 CAGR

Grossloansandadvances 914 2,192 3,238 5,607 10,916 85.9%

Loans inarrears 106 247 326 350 626 55.9%

Loanprovision 111 171 256 382 845 66.1%

Arrears/Grossloans 11.6% 11.3% 10.1% 6.2% 5.7%

Arrearscoverage 105% 69% 79% 109% 135%

GrowthratesGrossloansandadvances 140% 48% 73% 95%

Loanarrears 133% 32% 7% 79%

Loanprovision 54% 50% 49% 121%

Coverageratiochange,pps 35% 9% 31% 26%

Source: Company reports, Legae Securities

Fig 3: Impairments/ Instalment ratio: Credit quality has been improving

Product tenor 2007 2010 2011

1month 1.6% 1.4% 1.2%3month 3.2% 3.8% 4.8%6month 6.9% 5.2% 5.4%12month 13.1% 10.9% 9.5%18month 24.3% 11.5% 11.2%24month 21.7% 11.5% 12.9%36

month 14.4% 11.4%

48month 50.8% 30.3%60month 153.8%


The net impairment charge is what hits the incomestatement, and it is a sum of new provisions and writebacks: Getting to what matters most - the earnings - we knowthat the net impairment charge (also referred to as bad debt

charge) is what knocks the profit/loss account (some banks deduct

the whole provision amount). We know that theoretically,provisions have a considerable impact to earnings (i.e. netimpairment (bad debt) charge = new provisions minus provisions

released (i.e. no longer required) minus recoveries on write-offs;giving the rand value of loans written-off). Capitecs financial datashows a gross loan impairment figure (which presumably shouldbe new provisions minus provision release). The banks

conservative provision policy (i.e. accelerated provisioning) hasnegative accounting impact to earnings. The bound in gross


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impairment is a result of strong provision and conservativeprovision release. Given that the other portion of write backs,

namely recovery has been enjoying volatile growth rates(especially relative to loan growth) and the recoveries/arrearsratio is fairly stable below 20%, we believe a conservative release

of unwanted provisions is in order. In terms of the net impairmentvariable, we believe the bank is generous in its treatment of majorsegments (i.e. new provisions and release of unwantedprovisions). Despite the high credit risks in its market segment,

the NPL overhang risk is almost non-existent, in our view. As wementioned before, earnings visibility is increased by the banksprovision policy. (see Fig 4).

Conclusion on credit risks: We accept that the sources of thebanks risks are risky. The high required Capital Adequacy Ratio

(CAR) by regulators points to Capitecs elevated risks. We believecomparable lower quality assets (credit risk) and limited access tofunding when compared to mainstream and bigger banks (fundingrisk) are the primary risks. Balance sheet mismatches is a risk, butin this case we see it as a constructive risk as it is supportive toliquidity management. In our view, it seems as if management are

aware of the banks credit risks, and often seek to show pro-activeness that reduces future risks to earnings.

Fig 4: Net impairments: Inflated by higher provision; We covet the prudence.

Rand,mn 2007 2008 2009 2010 2011 CAGR

Grossloanimpairment 183 265 514 620 1088 56%

less recoveriesonwriteoff 22 35 46 72 100 46%

Netimpairmentcharge 161 230 468 548 988 57%Growthrates,%Grossloanimpairment 44.8% 94.0% 20.6% 75.5%

less recoveriesonwriteoff 59.1% 31.4% 56.5% 38.9%

Netimpairmentcharge 42.9% 103. 5% 17. 1% 80. 3%Ratio,%Recoveries/Arrears 20.8% 14.2% 14.1% 20.6% 16.0%

Netimpairment/Gross loans 17.6% 10.5% 14.5% 9.8% 9.1%



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2. CAMEL and ROE : Where could be

the weaknesses?

Below we discuss the key CAMEL indicators. With the exception ofasset quality, which is taken care of by higher provisions and

higher capital levels, we believe that the CAMEL ratios are strong.

Capital: We believe the bank currently carries ample capital.However, while a reported CAR of 38% (vs. 25% required by

regulators) looks high on face value, for continued stronggrowth in Risk Weighted Assets (RWAs) we believe this >10%buffer could soon run thin. Focus could also turn more totangible (book) equity (i.e ability to absorb losses) than risk-

based capital given the vulnerability of the banks loan book

(unsecured) to negative economic conditions. Nonetheless, wenote that subordinated debt (Tier 2 capital) at R420mn is ~11%

of the Tier 1 capital, providing room for further expansion of theTier 2 capital. The bank also possesses opportunities to raisecapital by issuing BEE shares (as we notice no such shareholder

exist yet). The banks internal capital generation has also beenstrong, with retained earnings expanding from R142.3mn inFY05 to R1.267bn by FY11.

Asset quality: We discussed and highlighted our opinionsrelated to asset quality in Section 1. We believe the industry isrisky, hence the regulators require a higher CAR of 25% forCapitec. However, we take comfort in the provision policy of thebank that provides higher arrears coverage ratios and

accelerates writing-off NPLs. (please refer to section 1 above). Management/ Efficiency: The cost/income ratio (efficiency

ratio) has improved from 66% in FY06 to 48% in FY11

notwithstanding the increase in branch network, ATMs andheadcount. The burden ratio, which measures the amount ofnon-interest expense covered by non-interest income, hasimproved to 24% from 41% in FY06.

Earnings/ Profitability: There are two main developments weexpect 1) interest spreads and NIM will compress due to higher

cost of deposits (as the bank increases its retail fixed deposits)and asset yields decline on competition; 2) fee income to play amore important role due to rising number of customers and

increasing transactional value (as the bank migrates to higherincome segments contrasted to history). The asset sensitive

balance sheet could however benefit from a reversal in interestrates (our Economist expects interest rates to start increasing in

1Q12) although the migration of the loan book to longer-datedloans could diminish the impact. The ROA, despite adeterioration, has been strong (5.5% for FY11 from 11% in

FY06) but the ROE could be higher should one consider the lowleverage as a result of higher CAR requirement.


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Liquidity and funding: The LDR increased to 96% as loansand advances growth (+93%) outpaced deposits growth

(+42%) considerably for FY11. This deterioration weakens thebanks internal funding ability. The encouraging aspect, despitethe deterioration in the LDR, is that the balance sheet is asset

sensitive (i.e. loans and advances average duration < averagedeposits duration) so the liquidity gaps are mostly positive orsmall when negative. However, the liquid assets/total assetsratio declined from 27% in FY10 to 20% in FY11 despite an

increase of the liquid assets to R2.8bn. We believe the bank isbuilding a strong deposit franchise which should support itsliquidity and funding. This is indicated by the high organic core

deposits momentum. Retail deposits growth has been pleasingwith retail fixed deposits increasing from R265mn in FY09 toR2.3bn by FY11, (before FY09 the bank was not accepting

deposits of fixed nature) while retail call deposits have

registered a 5-year CAGR of 133% to R3.954bn by FY11. TheCPA could, however, increase both the cost and sensitivity of

Capitecs (and the system) funding operations. We believe thecontrolled migration to relatively affluent customer bracketcould support further strong growth in deposits (i.e. depositbalances could increase). Growing fixed term retail funding

remains central to managements deposit mobilisation strategy.

Debt distribution is not a major worry, according tomanagement: Management is confident that they can raisewholesale deposits should the need arise. A maturity of R490mn

this year is not a worry to management, so we figured.Management indicated a strong likelihood of a roll-over. Nextyears R1.027bn maturity could probably be more concerning. It

is 13% of retail deposits. If the bank fails to refinance the bondin the wholesale market, it would need to grow retail deposits

by a minimum of 13% just to fill up that liquidity gap. However,we believe the improving spread of Capitecs debt isconfirmation/an indicator of reasonable appetite for CPI SJ

paper in the debt markets. (see Fig 5).

Fig 5: Debt distribution: Some heavy maturity in FY12; Spread contracting

490

1,022

0

140

0

160 150

490

1,512 1,512

1,652 1,652

1,812

1,962

500

1,000

1,500

2,000

2,500

2011 2012 2013 2014 2015 2016 2017

CYMaturities,Rmn

Cumulativematurities, Rmn

5.0

5.2

5.4

5.6

5.8

6.0

6.2

Nov09

Dec09

Jan10

Feb10

Mar10

Apr10

May10

Jun10

Jul10

Aug10

Sep10

Oct10

Nov10

Dec10

Jan11

Feb11

Mar11

Capitecswapspread(mat. 2016) aver age

Source: Bloomberg, Legae Securities


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ROE decomposition: Cost of liabilities is rising, and assetrotation is falling: Our ROE has consistently been different, and

relatively poorer to the one reported by management. However,for consistency we continue to use our method. (we also use thesame method for other banks under our coverage, so comparisonis not an issue). We decompose the ROE beyond the traditionalasset rotation, asset margin and leverage variables. (see Fig 6).

We expand the ROAs asset rotation and the expense ratio furtheras we seek to gain more insight in banks strengths andweaknesses. We note that :

The interest expense ratio: The interest expense ratio hasbeen increasing due to the rising cost of liabilities andincreasing volume of interest bearing liabilities. According tomanagement, the introduction of fixed term deposits had a

major impact to this figure. However, in FY11, the cost ofliabilities declined slightly to 8.0% which is still considerablyhigher than the 5.1% enjoyed in FY05. The volume of interestbearing liabilities has increased materially between FY06(42.6%) and FY11 (74.4%). In our view, the rising interestexpense ratio is logical as the bank has been growing its deposit

franchise and introduced fixed term deposits;

The total expense ratio: Despite a rising interest expenseratio, the total expense ratio has been moving in contrast. The

expense ratio has consistently declined, mainly due to thetechnological leverage benefits hence the non-interest expenseratio has substantially declined from 64.2% in FY06 to 19.9% inFY11. Efficient use of branch network is crucial to the decline of

this ratio. The staff costs/total costs is ~50%;

The interest income ratio: The ratio has declined, which isexpected given the impact of the NCA, competition, and theinternal objective by management to gradually reduce the costof credit. Yield on assets reduced from 76.2% in FY06 to 23.5%by FY11, notwithstanding the increase in the loans/assets ratioto 84% in FY11 from 44.2% in FY06. The industry has been

eating away the super profits, and will continue to, in our view.

Asset rotation: In spite of Capitecs strong position inunsecured lending, asset rotation has materially reduced. This islogical given the rising penetration in the unsecured lending

space. Nonetheless, the non-interest income ratio hasincreased, expanding from 17.1% in FY06 to peak at 35.2% inFY08 before declining in FY11 to


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required by the regulators. The ROE remains appealing,particularly given the appreciable ROA rather than leverage.

Fig 6: ROE decomposition cost of liabilities rising, asset rotation falling but ROA remain strong

2006 2007 2008 2009 2010 2011 2012F 2013F 2014F

Costofliabilities:int.exp/Averageliabilities 7.9% 7.9% 7.3% 10.2% 8.7% 8.0% 9.0% 8.8% 8.6%Compositionofliabilities:liab./aTA 49.6% 51.2% 54.5% 66.8% 78.3% 78.4% 78.5% 81.5% 82.8%Volumeofint.bearingliabilities:IBL/aTA 66.9% 62.4% 67.0% 90.1% 107.4% 91.9% 93.4% 93.5% 92.3%Interestexpense/AverageTotalassets 3.9% 4.1% 4.0% 6.8% 6.8% 6.3% 7.1% 7.2% 7.1%Noninterestexpense/Average Totalassets 64.2% 46.4% 39.3% 35.7% 24.7% 19.9% 17.7% 17.2% 16.9%

Impairmentcharge/AverageTotalAssets 9.3% 9.4% 9.0% 11.8% 7.6% 8.3% 8.7% 8.3% 7.9%

Expenseratio:Expense/AverageTotalassets 77.4% 59.9% 52.3% 54.3% 39.1% 34.5% 33.4% 32.8% 31.8%Incometax/Average Totalassets 4.9% 4.4% 3.7% 3.5% 2.7% 2.4% 2.2% 2.1% 2.3%Yieldonassets:Int.income/assets 76.2% 56.2% 28.9% 30.7% 24.4% 23.5% 20.5% 19.3% 18.6%Compositionofassets:Loans/aTA 44.2% 46.7% 78.8% 75.4% 72.3% 84.2% 91.2% 90.0% 87.2%Volumeofearningassets:IEA/aTA 100.8% 107.3% 102.9% 113.7% 107.8% 107.9% 100.1% 96.5% 95.3%Interestincome/AverageTotalassets 76.2% 56.2% 28.9% 30.7% 24.4% 23.5% 20.5% 19.3% 18.6%

Noninterestincome/AverageTotalassets 17.1% 17.7% 35.2% 35.1% 23.5% 18.8% 20.2% 20.3% 20.9%

Otherincome/Averagetotalassets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Assetrotation:Revenue/AverageTotalassets 93.3% 74.0% 64.0% 65.8% 48.0% 42.3% 40.7% 39.6% 39.5%ReturnonAverageAssets 11.0% 9.7% 8.0% 8.0% 6.2% 5.5% 5.1% 4.8% 5.4%Leverage:Av.Totalassets/av.Equity 2.0 2.3 2.5 3.4 5.1 5.0 5.0 5.7 6.1ReturnonAv.Equity:Expandedmethod 21.8% 21.8% 20.3% 27.3% 31.7% 27.5% 25.4% 27.6% 33.0%ReturnonAv.Equity:Totalearnings/Av.totalequity 22.2% 19.9% 19.6% 24.3% 28.7% 25.3% 23.6% 25.9% 31.3%ReturnonAv.Equity:Ord.earnings/Av.Ordequity 22.2% 20.9% 20.9% 25.9% 30.8% 26.9% 24.9% 27.0% 32.3%



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3. Assumptions and valuation

Assumptions: Inferior to history but on trend, andconservative to management guidance: Our CAMEL and ROEanalysis informs our assumptions. Key issues we note are 1) thecost of liabilities is rising, and we expect it to continue to increase

as the fixed deposits mobilisation gathers pace; 2) asset rotationhas been reducing on declining interest income/earning assets. Wetherefore take this trend into consideration for our assumptions.Balance sheet items: 1) Deposit growth. We reduce the

growth of retail deposits (both fixed and call) despite ourconviction that management are building a robust depositfranchise. Note that retail deposits/total deposits ratio has now

reached managements target of 60%. We increased wholesalefunding growth to 35% although it remains below the historicalgrowth rate by a wide margin. Compared to our initial forecasts,we reasonably increased our deposit growth rate postmanagement meeting. 2) Loans: We model loans and advancesusing the LDR. We expect the LDR to slightly exceed 100% this

year as some of the capital raised could be lend out. (some will gotowards branch network development etc). Management do notforesee major headwinds to loan growth. Our average loan growth

forecast of 37% is below the average growth rate of 94% betweenFY06 and FY11.Income statement items: We reduce the interestincome/earnings assets to an average of 20%, and increase the

interest expense/bearing liabilities to 8%. Important to highlighthere is that we follow the trend. Management believe that a

rebound in interest rates could provide a fillip to interest income,and the growing deposit franchise could lead to lower cost ofdeposits, nevertheless. We reduce the loan fee income ratio butincreased the transaction fee income ratio as we expect the bankto leverage its growing deposit franchise (and the rising number of

clients). We reduce the net impairments/loans ratio to 9.5% forFY12; average 9.3% for our forecast period. (FY06 21.0%; FY119.8%) as we expect improved economic condition to aid write-backs (release of provisions and recoveries). We reduced the

banking operations ratio to 11.5% and maintained it at that levelfor the forecasting period. (see Fig 7).Growth rates: Our assumptions crystallise into an earningsgrowth rate of 34% for FY12 (vs. prev. 33%) to R876.2mn and a

CAGR of 34% over our forecasting horizon. Our earnings growthrate is supported by strong growth in transactional income (+93%)while we are rather cautious, when compared to history, on netinterest income growth (+13%) in FY12. We expect the balancesheet to grow by a 32% CAGR, supported by strong loan and

advances and deposits (37% and 36% respectively). (see Fig 8).


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Fig 7: Salient balance sheet an d income statement assum ptions

2006 2007 2008 2009 2010 2011 2012F 2013F 2014F

Key balance sheet assumptions

Wholesale deposits 1.9% 498.9% 84.8% 167.4% 117.1% 7.8% 35.0% 30.0% 25.0%

Retailcalldeposits 141.8% 3.0% 52.0% 55.1% 79.6% 67.6% 50.0% 30.0% 20.0%

Retail fixeddeposits n/a n/a n/a n/a 333.2% 101.7% 75.0% 55.0% 35.0%

Totaldeposits 594,996 896,000 1,474,000 3,261,000 7,163,000 10,203,000 15,290,400 20,890,770 26,358,210

Loan/depositratio 76.4% 89.6% 137.0% 91.4% 72.9% 98.7% 103.0% 100.0% 98.0%

Loansandadvances 454,661 803,260 2,019,200 2,981,685 5,225,139 10,071,466 15,749,112 20,890,770 25,831,046

Key income statement assumptions

Interestincome/Interest EarningAssets 75.6% 52.4% 28.1% 27.0% 22.6% 21.7% 20.5% 20.0% 19.5%

Interestexpense/InterestBearingliabilities 6.7% 7.8% 6.9% 8.3% 6.8% 7.4% 8.0% 8.0% 8.0%

Loanfee income/Loans 0.0% 9.6% 28.5% 30.1% 18.9% 11.4% 10.0% 10.0% 10.0%

Transactionfee income/TotalAssets 3.5% 4.3% 5.7% 5.7% 5.3% 6.1% 8.5% 9.0% 10.0%

Fee expense/Total Assets 2.3% 2.7% 3.0% 2.9% 2.2% 2.4% 2.6% 2.7% 2.6%

Netimpairmentcharge/Loans 21.0% 20.1% 11.4% 15.7% 10.5% 9.8% 9.5% 9.3% 9.0%

Otherincome/TotalAssets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Bankingop.expense/Total Assets 40.0% 27.7% 26.0% 21.4% 14.4% 12.6% 11.5% 11.5% 11.5%

Nonbankingop.expense/Total Assets 0.5% 0.3% 0.3% 0.3% 0.2% 0.2% 0.3% 0.2% 0.2%

Incometaxexpense/ProfitBeforeTax 30.6% 31.4% 29.4% 30.1% 30.1% 30.2% 30.3% 30.2% 30.0%



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Fig 8: Salient balance sheet and income statement grow th rates

2007 2008 2009 2010 2011 2012F 2013F 2014F

Interest income 967,528 740,063 1,212,896 1,763,966 2,808,543 3,544,167 4,478,728 5,504,374

Interest expense 69,836 101,449 269,621 490,636 751,360 1,223,232 1,671,262 2,108,657

Net interest income 897,692 638,614 943,275 1,273,330 2,057,183 2,320,935 2,807,466 3,395,717Net fee income 111,557 653,400 1,035,709 1,281,573 1,683,595 2,759,347 3,760,162 5,003,445

Loan fee income 76,943 574,584 897,502 986,199 1,151,864 1,574,911 2,089,077 2,583,105

Transaction fee income 93,671 168,361 281,548 507,438 883,040 1,708,513 2,368,712 3,289,993

Fee expense 59,057 89,545 143,341 212,064 351,309 524,078 697,627 869,652

Net impairment charge 161,271 230,879 467,727 547,731 988,177 1,496,166 1,932,396 2,324,794

Income from operations 856,690 1,095,291 1,533,051 2,029,495 2,775,471 3,624,713 4,688,462 6,140,844Banking operation expense 606,705 762,540 1,063,672 1,368,324 1,812,499 2,311,518 3,026,687 3,783,492

Non-banking operating expense 6,808 8,405 12,696 18,815 22,672 56,427 65,289 78,183

Operating income before tax 243,177 324,346 456,683 642,356 940,300 1,256,768 1,596,486 2,279,169Profit for the year 166,924 229,065 319,332 449,224 656,024 876,158 1,113,835 1,594,402

Dividends 49,200 61,400 91,100 166,796 270,825 343,454 436,623 625,006

EPS 194 259 363 524 686 919 1,169 1,673Loans and advances 803,260 2,019,200 2,981,685 5,225,139 10,071,466 15,749,112 20,890,770 25,831,046

Total Assets 2,191,642 2,936,372 4,969,422 9,488,223 14,439,517 20,100,159 26,319,021 32,899,930Deposits at amortized costs 842,172 1,475,696 3,298,897 7,360,325 10,449,883 15,290,400 20,890,770 26,358,210

Total liabilities 1,074,185 1,718,945 3,563,221 7,760,246 10,989,004 16,130,996 21,694,923 27,338,324Share capital 647,363 647,363 674,369 682,219 1,918,677 1,918,677 1,918,677 1,918,677

Retained Earnings 313,049 415,458 601,099 906,991 1,276,336 1,791,517 2,446,452 3,383,960

Ordinary share capital 962,851 1,062,821 1,251,595 1,573,371 3,191,544 3,710,194 4,365,129 5,302,637

Total Equity 1,117,457 1,217,427 1,406,201 1,727,977 3,450,513 3,969,163 4,624,098 5,561,606Growth rate s

Interestincome 23.4% 23.5% 63.9% 45.4% 59.2% 26.2% 26.4% 22.9%

Interestexpense 74.2% 45.3% 165.8% 82.0% 53.1% 62.8% 36.6% 26.2%

Netinterestincome 20.7% 28.9% 47.7% 35.0% 61.6% 12.8% 21.0% 21.0%

Netfee income 646.6% 485.7% 58.5% 23.7% 31.4% 63.9% 36.3% 33.1%

Loanfee income n/m 646.8% 56.2% 9.9% 16.8% 36.7% 32.6% 23.6%

Transactionfee income 111.4% 79.7% 67.2% 80.2% 74.0% 93.5% 38.6% 38.9%Feeexpense 101.1% 51.6% 60.1% 47.9% 65.7% 49.2% 33.1% 24.7%

Netimpairment charge 68.6% 43.2% 102.6% 17.1% 80.4% 51.4% 29.2% 20.3%

Nonbankinggrossprofit 22.3% 36.3% 66.6% 13.9% 7.3% 80.6% 30.9% 25.0%

Incomefromoperations 27.5% 27.9% 40.0% 32.4% 36.8% 30.6% 29.3% 31.0%

Bankingoperationexpense 21.3% 25.7% 39.5% 28.6% 32.5% 27.5% 30.9% 25.0%

Operatingincomebeforetax 46.4% 33.4% 40.8% 40.7% 46.4% 33.7% 27.0% 42.8%

Incometaxexpense 50.0% 25.0% 44.2% 40.6% 47.2% 33.9% 26.8% 41.9%

Profitfortheyear 44.8% 37.2% 39.4% 40.7% 46.0% 33.6% 27.1% 43.1%

Cashandcashequivalents 79.2% 40.8% 145.0% 69.5% 10.7% 45.8% 2.4% 59.5%

Loansandadvances 76.7% 151.4% 47.7% 75.2% 92.8% 56.4% 32.6% 23.6%

TotalAssets 75.2% 34.0% 69.2% 90.9% 52.2% 39.2% 30.9% 25.0%

Deposits 56.6% 75.2% 123.5% 123.1% 42.0% 46.3% 36.6% 26.2%

Totalliabilities 56.3% 60.0% 107.3% 117.8% 41.6% 46.8% 34.5% 26.0%

Sharecapital 86.1% 0.0% 4.2% 1.2% 181.2% 0.0% 0.0% 0.0%

RetainedEarnings 45.4% 32.7% 44.7% 50.9% 40.7% 40.4% 36.6% 38.3%

Ordinarysharecapital 70.8% 10.4% 17.8% 25.7% 102.8% 16.3% 17.7% 21.5%

TotalEquity 98.2% 8.9% 15.5% 22.9% 99.7% 15.0% 16.5% 20.3%



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Page 12 of 16

Valuation: We reduce our sustainable grow th rate from 15%to 14.25%, FY12 TP increase slightly to 17499c, remains a

HOLD: Our FY12 TP did not change materially, despite ourdownward revision in the growth rate (the ROE increasecompensated for it. Our moderate upward adjustment to depositsled to an increase in loans and advances, and consequentlyprofitability), moving slightly to 17499c. (a product of our Justified

Price/Book value ratio of 4.4X and our FY12 Book value per shareof 3972c). (see fig 9). At the current price of 16730c (c.o.b April 12010), the upside potential remains within our HOLD band. Wewould BUY on weakness. Our FY12 TP shows an implied forward

PER of 19X vs. the current prices forward PER of 18.2X (FY12Legae EPS estimate).

Why revise the growth rate? Estimating sustainable growth rateis often subjective and debatable, yet it is a key input in valuation.Generally, investors apply an attainable nominal GDP growth rate

(the upper end of South Africa often being 12% i.e. 6% real GDPgrowth plus 6% inflation rate). Some investors apply an impliedlong-term growth rate obtained as a product of the retention ratio

and the sustainable ROE. For Capitec, using a sustainable ROE of28.6% and a retention ratio of 60% (we notice a dividendcoverage ratio has consistently been ~2.5X i.e. 40% payout ratio),this sustainable long-term growth rate would be 17.2%. We

reduce the growth rate mainly to reflect our concerns related tocompetition and capital level. At some point, we know Capitec willface mid-life crisis, hence our cautious approach to growth when

contrasted to the theoretical growth rate although it is still 2.25ppsabove the upper nominal GDP growth rate expectation.

Valuation risk remains high (see sensitivity analysis, Fig10), but growth outlook is intact as well: In our view,valuation risk remains high (relative to mainstream banks), but webelieve the growth outlook remains intact in our forecast period. Infact the put-off is the valuation risk, in our view. (see Fig 10).

Sensitivity analysis shows no easy upside at all, in our opinion.The PER at 1.7X the Banks PER and 1.8X the Small Cap Index PERlooks set for a reduction, particularly relative to history. After a

robust expansion in the PER to trade outside its +1 region, ithas contracted but remains at precarious levels. Valuation risks vs.other small cap companies also look colossal. However, despite

trading at a PER >1.6X the Banks index PER, Capitec is nowtrading closer to its traditional premium to the banks Index PER.(see Fig 11).

Share price has rallied and strongly outperformed, goodnews priced-in: The strong rally of the share price since mid-09and strong out-performance of the Banks Index and the Small Capindex points to pricing-in of most of our good news. The shareprice is susceptible to a correction as well.


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Fig 9: Valuation model: Our Justified PBVR is 4.4X

AverageROE 28.65%

Sustainablegrowthrate 14.25%

CostofEquity 17.5%

JustifiedPBVR(ROE g)/(CoEg) 4.4

2012BVPS 3972.9

FY12Targetprice 17499

Currentshareprice 16730

Potentialcapitalgain 4.6%

ForecastDividendyield 2.1%

Potentialtotalreturn 6.7%

Source: Company reports, Bloomberg, Securities

Fig 10: Sensitivity analysis: No more easy upside .

GrowthrateROE 8.00% 9.75% 10.25% 12.00% 14.25% 15.00%

15.0% 2921 2684 2595 2159 911

25.0% 7094 7797 8061 9356 13061 15765

28.65% 8619 9665 9974 11985 17499 21524

30.0% 9181 10330 10793 12955 19135 23648

35.0% 11268 12911 13525 16554 25210 31531


Fig 11: The PE relative to the Banks and Small cap indices and history show s no easy upside as w ell

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Source: I-Net, Legae Securities


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Page 14 of 16

Fig 12: Performance, PERs and Dividend yields: Investors have been and are paying for grow th...

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Fig 13: ...and the outperformance has been phenomenal, pricing in m ost of our good news.

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Legae Securities (P ty) Ltd

Member of the JSE Securities Exchange

1st Floor, Building B, Riviera Road Office Park, 6-10 Riviera

Road, Houghton, Johannesburg, South Africa

P.O Box 10564, Johannesburg, 2000, South Africa

Tel +27 11 551 3601, Fax +27 11 551 3635

Web: www.legae.co.za, email: [email protected]

Analyst Certification and Disclaimer

I/we the author (s) hereby certify that the views as expressed in this

document are an accurate of my/our personal views on the stock or sector

as covered and reported on by myself/each of us herein. I/we furthermore

certify that no part of my/our compensation was, is or will be related,

directly or indirectly, to the specific recommendations or views as expressed

in this document

This report has been issued by Legae Securities (Pty) Limited. It may not bereproduced or further distributed or published, in whole or in part, for any

purposes. Legae Securities (Pty) Ltd has based this document on information

obtained from sources it believes to be reliable but which it has not

independently verified; Legae Securities (Pty) Limited makes no guarantee,

representation or warranty and accepts no responsibility or liability as to its

accuracy or completeness. Expressions of opinion herein are those of the

author only and are subject to change without notice. This document is not

and should not be construed as an offer or the solicitation of an offer to

purchase or subscribe or sell any investment.

Important Disclosure

This disclosure outlines current conflicts that may unknowingly affect the

objectivity of the analyst(s) with respect to the stock(s) under analysis inthis report. The analyst(s) do not own any shares in the company under

analysis.

Disclaimer & Disclosure

CPI SJ_A Critique on Credit Risks & ROE_Solid Footing but We Maintain Our HOLD on Valuation Risk

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Transcript of CPI SJ_A Critique on Credit Risks & ROE_Solid Footing but We Maintain Our HOLD on Valuation Risk