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Junk makes banks a bargain buy

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Johannesburg - Foreign investors have been snapping up South African banking stocks, enticed by the cheapest valuations relative to emerging-market peers since 2011, even as the country’s downgrade to junk deepened a broad equity selloff.

Offshore investors bought a net R1.5 billion of bank shares, including those of FirstRand and Barclays Africa Group, in the six days after S&P Global Ratings downgraded the South Africa’s foreign currency debt on April 3. Fitch Ratings followed with a similar cut on April 7, described by a banking industry body as “ devastating” for lenders. Excluding bank shares, foreigners sold a net R2 billion of other stocks in the same period, bringing equity outflows this year to R43.8 billion, according to JSE data.

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The logos of three of South Africa's four biggest banks - Absa, Standard Bank and First National Bank - adorn buildings in Cape Town. Picture: Mike Hutchings

Valuations of the country’s banks have plunged to 10 times historical earnings, compared with 19 for the benchmark FTSE/JSE All Share Index. While facing higher costs of capital, rising bad debts and a slowdown in lending, banks are well capitalized to withstand the storm and cheap enough to be bargains, said Adrian Cloete, an analyst at PSG Wealth in Cape Town.

“Banking shares are looking interesting from a valuation perspective,” Cloete said by email. “The current almost-50 percent discount is very large compared to the long term trading history” and the lenders are offering “very attractive dividend yields,” he said.

South Africa’s four biggest banks were profitable through the global financial crisis of 2008 and the country’s recession a year later. With the lenders better capitalised now than they were then, surveys compiled by Bloomberg show analysts expect them to remain profitable despite the downgrades and President Jacob Zuma’s firing of Finance Minister Pravin Gordhan in March.

Read also: S&P downgrades SA banks

Banks have been preparing for the downgrades, and even Gordhan’s removal, since Zuma roiled markets when he fired former Finance Minister Nhlanhla Nene in December 2015, said Neelash Hansjee, banks analyst at Old Mutual in Cape Town.

Still at risk

Still, South Africa remains at risk of further downgrades and the political situation is far from stable. Opposition parties marched on Wednesday to call for Zuma’s ouster, and Parliament may debate a motion of no confidence in the president pending the conclusion of an application to the country’s top court seeking a secret ballot.

In the days after S&P’s rating downgrade the rand, which had been the world’s best-performing currency in 2017, gave up the year’s gains while bond yields spiked, increasing the banks’ cost of capital. That means investing in banks right now may be risky, though cheap.

Not all investors are convinced. Policy uncertainty will continue to weigh on South African assets, said John Ashbourne, a London-based economist for Africa at Capital Economics Ltd. The ruling African National Congress is holding a policy conference in June after Zuma promised “radical economic transformation” following Gordhan’s dismissal.

“I don’t see any silver lining for the nation’s banks,” Ashbourne said. “We’re waiting for the policy conference in June for any signs of changes in the nation’s tax and spending policy. Before that happens, there’s way too much uncertainty.”

The hardest hit bank share this year is Barclays Africa, which has to contend not only with strife in its home market, but also its parent company’s planned sale of stock. The six-member banks index has slumped 6.3 percent since the first downgrade, compared with a 3.1 percent gain in the 164-member All Share Index. The bank gauge is the worst-performing index in South Africa this year and by the end of March had suffered its poorest first quarter in eight years.

That shouldn’t deter bargain hunters, PSG’s Cloete said.

“The bottom line is that South African banks’ balance sheets and capital ratios are very healthy, which should be very comforting to investors,” he said. “They are very profitable with high returns on equity.”

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