Investing in quality or quantity?

The Barclays eagle took off on February 11 2014, marking the beginning of the December 2013 reporting season.

Kumbirai Makwembere

Traditionally, Barclays is always one of the first banking institutions to release its numbers. Banking results come to the market at a time when the economy is experiencing a severe liquidity squeeze.

Companies in virtually all sectors of the economy are currently struggling to service their obligations to banking firms. Banking results thereby help in determining the likely overall health of the economy.

Market interest this time around was increased following the profit warning published by NMB.

Amongst indigenous banks, the market is slowly coming to regard it as a safe institution following the increase in the stake held by offshore investors to 50,86%.

Furthermore, management at the bank has been proactive with regards to providing for non-performing loans. The institution revealed that it will record a loss in the 12 months to December 31 2013 owing to increased provision for non-performing loans.

Therefore disclosing that provisions had gone high is indicative conditions have further deteriorated in the business environment.

Barclays, as expected, maintained the model it christened the safe banking approach. This is characterised by conservative growth of a quality loan book.

In addition to this, the group has undertaken to focus on e-channels for delivering its products. Barclays’ net interest income for the period rose by 61% to US$12,3 million. The increase was a result of the 26% growth realised in the loan book at US$115,3 million. Growth in credit outpaced the 10% increase recorded in customer deposits to US$248 million.

Non-interest income for the year, nonetheless dipped by 9% to US$27,2 million. Management attributed the decline to the coming into effect of the Memorandum of Understanding signed between banks and the Reserve Bank of Zimbabwe.

Operating profits for the period rose by 75% to US$4,9 million benefitting from improved operational efficiencies. Total income for the year rose by 5% to US$38,8 million whilst operational costs were static at US$34 million.

The company’s cost to income ratio improved to 85% from 90% owing to staff rationalisation carried out over the years as well as the automation of processes. Profit after tax for the year came in at US$2,95 million equating to a 43% growth over 2012 levels.

Growth in the loan book, however, resulted in impairment losses going up by 40% to US$0,7 million.

The loan-to-deposits ratio in the process increased by 6 percentage points to 47% but undoubtedly remains the lowest in the sector. However, the level of non-performing loans remained below 1%, a great feat considering the sector average of 15,92%, Some institutions are even rumored to be sitting on ratios north of 20%.

Turning to the balance sheet, Barclays signalled its focus on core banking with interest earning assets accounting for 82% of total assets. Unlike other bankers, the liquidity ratio of 53% also illustrated how proactive they have been in enhancing their cash position in such a demanding environment.

One cannot however avoid noting the huge earnings growth potential that the bank has considering its asset base. Better returns could be realised for shareholders if the bank conservatively increased its lending book from current levels.

Instead of only focusing on the firms that were traditionally regarded as blue chips, which are presently struggling, the bank could target medium sized companies that are in good shape and are growing. These are the institutions that have been taking away market share from the once big companies.

For instance, CFI has lost its leader position in the eggs and chicken space to smaller players. The same can also be said in the dairy industry following the entrance of players like Dendairy, Kefalos and Alpha & Omega.

But again, increasing the level of loans will at some point result in defaults kicking in. What is therefore key is to strike a balance in growing profits through credit growth and at the same time keeping the level of non-performing loans low. Furthermore, timing is of the essence as the current slowdown in the economic landscape will impact negatively on the ability of individuals and corporates to service their obligations.

Additionally, there is room for the bank to grow its treasury income through discounting quality assets from other market players. Some smaller banks that are experiencing liquidity challenges have some quality assets that the bank can predate on as these players are desperate for liquidity injections. Caution must be exercised in engaging in such activities as thoroughness is required in assessing some of the so-called quality assets originated by small banks.

Whilst the company’s model of being a safe bank is commendable in the current environment, earnings might not sustain the company’s share price. Barclays last traded at US 0,42 cents and this translates to a historical PE of 30x which is way higher compared with other listed banks namely, CBZH and FBCH.

The duo is presently trading at ratios of 2,7x and 5x, respectively. This presents a dilemma for investors interested in banking stocks on which counter to pick.

There is the Barcalys option of buying into a counter that appears overvalued but getting comfort in that the bank has quality assets and declares profits that appear realistic. Alternatively, one can pick the seemingly cheaper banks with profits that are questionable.

For a long time now the market has always questioned the level of provisions for non-performing loans in traditional banks, particularly CBZH.

 

 

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