Market's stunned reaction to Nedcor's results reveals a widening credibility gap

Time of article published Aug 2, 2003

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Nobody expected glowing results from Nedcor this week, but the market was shocked by the extent of the drop in interim earnings and a raft of problems across the spectrum of the business. A huge headline earnings fall to 244 cents a share from 630 cents in the same period last year is certainly most disappointing.

The market reacted quickly, knocking the share price down by four percent to R94 just hours before the official release of the results on Tuesday evening. The blood didn't stop flowing there and yesterday the share opened at R85.70 - representing a R3.378 billion loss of market value - before dropping below R85 by midday. The share has now fallen by 53 percent from it's all-time high of R180 three years ago.

Nedcor CEO Richard Laubscher has had a difficult time of late. Senior management's image was badly hurt in 2001 when a controversial scheme to pay certain executives a percentage of gains made on information technology investments was floated. The investment community was furious.

The remuneration did not relate to the performance of the executives. In fact, they had no operational involvement in the underlying investments. The scheme was eventually abandoned by management, who still seemed unrepentant.

Another sad tale management will probably never be forgiven for is the mismanagement of the Dimension Data (Didata) investment. At the height of the technology boom it seemed the directors had missed their calling, and that they should concentrate on investment management. Unfortunately this did not last and no shares were sold nor hedged. Didata has fallen from a high of R70 to the current level of around R3. Didata, which featured prominently in past growth plans, was a strategic investment, not a portfolio investment, Nedcor's management argues, so traditional steps were not taken to protect the position.

So shareholders are licking their wounds and probably don't know which way to turn. All an investor wishes for is steady profit growth, with a step-like increase in dividends year after year. Some would settle for pedantic profit growth.

Analysing bank shares is notoriously difficult, with many variables coming into play and historically many ways of manipulating and smoothing earnings. Nedcor seems to have run out of road and the share price is displaying the stability of a marionette on a string. The profit trend is gone, the uncertainty of the BoE merger remains, and management still has to navigate the tricky waters of the new black empowerment charter for financial services.

On top of this, the merger with BoE is costing more than expected, with the cost-to-income ratio deteriorating from 53.4 percent to 59 percent. A major concern for investors is management's huge credibility gap.

Analysts were also shocked to see that Nedcor's ratio of primary capital to total assets has now dropped to 6.3 percent, which is below the 7.5 percent that will be required under the Basel 2 Accord on capital, which comes into effect in 2005. Laubscher, however, reassured shareholders that Nedcor would ensure that its profits would grow so as to restore its primary capital position. This remains to be seen.

In an extraordinary development last week, Jim Sutcliffe, the CEO of Old Mutual, Nedcor's holding company, urged Nedcor to increase the clarity and transparency of its reporting. That this was necessary is in itself worrying.

The results are so bad many analysts now feel that a further profit warning should have been issued. Management had guided analysts' expectations lower, but this, as the share price shows, was clearly not enough. It appears the market expected results at least 30 percent better than those released on Tuesday.

In a world that is moving towards greater transparency and continuous disclosure, this is simply not good enough!

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