Investec results: Less cowboy, more quality
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The specialist banking and asset management group reported a robust set of results that demonstrate a business that is moving onto the front foot and capable of delivering stronger earnings growth in the future.
The group lifted operating profit by 18.5% to £599.1 million as the effects of the stronger rand over the year was felt in the translation of profits into British pounds (its reporting currency). Investec derived roughly 58% of its operating profit from its Southern African operations, with the balance predominantly coming from the United Kingdom and Europe.
Adjusted earnings per share rose by 16.9% to 48.3 pence, but included in this number is a bad debt charge of about six pence per share for the “legacy” assets in the UK that are being wound down. Stripping the legacy effect out, a more accurate picture of the group’s long-term sustainable earnings would indicate Investec earned about 54 pence per share in the year to end March.
In addition, it would also have been higher were it not for the way the group accounts for Investec Equity Partners (IEP), previously called Principal Investments. The company relinquished majority control of the entity through the introduction of strategic partners and this meant it moved from consolidating IEP into its own accounts, to accounting for it as an equity investment – where just income is booked in the income statement. “If we accounted for it , it would have added about 2.5 pence to our adjusted earnings per share, or an increase of a further 4%-5%,” said Investec CEO, Stephen Koseff. This means Investec more accurately grew earnings by more than 21% in the year to March.
Koseff took the opportunity to announce the launch of Investec Life at the results, a new offering for South African clients that will be formally introduced later this year.
Listen to Stephen’s interview with Warren Thompson here:
What would have been pleasing to investors is the balanced nature of the contributions, with solid underlying performance coming from all three major operating divisions in the group: Specialist Banking, Wealth & Investment and Asset Management.
Specialist Banking or the capital intensive part of the business which incorporates lending, investment portfolios and trading income, lifted operating profit by 11% to £454.4 million (63.8% of the group’s total). The improvement was greatly aided by the growth in core loans and advances which increased by 26.8% (8.5% on a neutral currency basis) to £22.2 billion. While loans increased faster than deposits did, Investec’s balance sheet is very conservatively funded, with the banks deposits - at £29.1 billion – almost £7 billion greater than its loans.
Asset management which has morphed into the most global franchise within the Investec stable, contributed operating profit of £164.8 million reflecting growth of 22.3%. This was made possible by the 25.9% increase in assets under management (AUM) that was almost entirely driven by favourable foreign exchange conversion and positive market movement. The business now oversees assets of some £95.3 billion globally roughly split 59:41 between emerging markets and developed markets.
Investec Wealth & Investment lifted operating profit by 8.8% to £93.2 million on the back of stronger net inflows into the South African business. The bulk of funds under management and operating profit comes from the UK and Europe. Operating margin declined slightly to 25.9% as the business sustains investment into digital platforms, IT Infrastructure and compliance. Headcount increased by 4.4%.
“I was a little bit disappointed with the asset management performance,” says Greg Saffy, principal at Cast-iron Capital. “The increase in assets under management was almost exclusively from the rise in markets, and what you want to see from a mature, quality business like this one is an increase in operating leverage. This means that earnings should grow faster than the growth in assets under management (AUM). And I didn’t see that. With AUM growing by 26%, there was only a 22% growth in operating profit.”
While a like-for-like accounting treatment of the Investec Equity Partners contribution would have yielded more earnings than what Investec reported (as discussed above), Saffy says the underlying performance of the business was sub-standard. “Off a capital base of £323 million, I estimate it delivered a return of £4 million, which is not good enough for a portfolio of businesses they have selectively assembled,” says Saffy.
But he couldn’t be anything other than impressed with the performance of Specialist Banking. “Finally what we are seeing from the two banking franchises (SA and UK) are niche, growing businesses that are demonstrating sustainability. I believe the earnings growth is of a high quality – of the highest quality I have seen in its history,” says Saffy, referring to the client base the division services at both a private and corporate level, the number of clients, and the transaction levels that support the earnings. “Gone are the days when Investec used to generate most of its earnings from transactional investment banking activities. Earnings are coming from many different areas within the division, it's much more sustainable, and as a result, I think the group justifies a higher multiple from the market.”
Investec Limited closed 2.2% higher in Johannesburg at R105.62 per share, and was flat at 601 pence per share in London at the time of writing. At the British pound price, the business is trading at a historical price-earnings ratio of 11.12x based on earnings per share of 54 pence.