Share Analysis: FirstRand - Financial services

The Company 

FirstRand is the third-largest South African bank in terms of balance sheet size, holding total assets of R979bn ($84.6bn) at December 31, 2014. It operates three primary brands: First National Bank, which has a retail and commercial focus; Rand Merchant Bank, which competes in the corporate and investment banking markets; and Wesbank, which provides vehicle and asset finance products. The company is listed on the Johannesburg Stock Exchange and it has a diverse institutional shareholder base. The largest shareholder is RMB Holdings with a 34.1% stake. The company has a June year-end.

For the financial half year ended December 31, 2014 FirstRand reported normalised earnings of R9.99bn ($863.1m) and diluted earning per share (EPS) of 177.3 cents ($0.15). Market consensus expectations for the financial year ended June 30, 2015 are for earnings of R21.165bn ($1.8bn) and EPS of 377 cents ($0.33).

In the financial half year ended December 31, 2014, the company derived 58% of its profit from First National Bank and 25% from Rand Merchant Bank, while Wesbank contributed 17%. The company delivered a 24% return on equity, driven by an industry-leading return on assets of 2.1%. At December 31, 2014, FirstRand’s common equity tier 1 ratio (a key measure of regulatory capital) was 13.8%, well above regulatory minimum levels.

The bank’s strategy in the aftermath of the global financial crisis has been to re-orientate the positioning of its different businesses. At First National Bank emphasis has been placed on growing the transactional and deposit franchise and adjusting the pricing of risk. Rand Merchant Bank has seen its business model move from being a highly leveraged market risk-oriented business to one more geared to facilitating customer flows. In addition, emphasis has been placed on expanding lending activities. Wesbank has also seen adjustments in pricing for risk while significant emphasis has been placed on improving this unit’s operational efficiency. In the Wesbank brand, additional revenue streams have been developed beyond the core Vehicle Finance unit, notably personal lending and MotoNovo, a UK-based vehicle finance business.

Development Strategy

The bank derives approximately 90% of its revenue in South Africa, the majority of other revenue coming from its operations in the rest of Africa. Given the linkage between a country’s economy and its banking system, FirstRand is heavily influenced by the state of the South African economy. The pace of economic growth in South Africa has been sluggish recently, the economy delivering nominal GDP growth of approximately 8% in recent years (with real GDP growth in the region of 2%). Reflecting slower economic growth, total banking credit formation in South Africa has slowed in recent years and is currently expanding at around 8% compared to a 10-year average of 12%. Banks are also heavily influenced by the interest rate cycle. Following a reduction in interest rates from 12% in late 2008 to 5% in 2012, the interest rate cycle in South Africa has turned. After three interest rate hikes between January 2014 and July 2015, the South African repo rate stands at 6% and market expectations are for further rate increases over the coming 18 months. While higher interest rates will boost the endowment income earned by banks, they also carry the risk of triggering deterioration in credit quality.

The rest of Africa remains FirstRand’s priority for expansion, given materially higher economic growth rates compared to South Africa, although so far this expansion has been organic.

FirstRand has looked at a number of possible deals in rest of Africa, however, to date no significant acquisitions in Africa have been concluded.