Plain Black or White Contrarian Value stock?

Investec - the Anglo South African Investment Bank and Asset Manager released a trading update yesterday. They started the Performance Overview with the following statement (or understatement) :
"Overall group results have been negatively impacted by the depreciation of the Rand: Pounds Sterling exchange rate over the period." To help get a feel for this as it is important to the investment case here see the Rand to Pound Graph. This along with other emerging market currencies has been under pressure on the back of concerns about tapering of the US Feds Quantitative easing. This has left the Rand at around five year lows against Sterling.

Now I'm not an economist, but on a cursory glance at Africa's economic outlook it looks OK, although high unemployment, funding of the trade deficit and a budget deficit (like many developed economies) seem to be the main concerns with the funding one being most pertinent in relation the withdrawal of QE and investors fleeing emerging markets. So you need to be aware of the currency risk with this one, but equally at five year lows, it could always go the other way for a while and become a tail wind rather than a headwind.

Despite this headwind Investec was still able to report total operating income 1% ahead and Operating profit before goodwill, acquired intangibles, non-operating items and taxation and after other non-controlling interests 12% ahead of the prior year. An increase of 25% on a currency neutral basis. It is also worth noting that recurring income as a percentage of total operating income amounted to approximately 74% (2012: 71%), supported by higher average funds under management. So I would suggest that the earnings are reasonable quality, albeit subject to market and currency volatility in the case of asset management fees. Since 31 March 2013 (the end of the group's financial year): Third party assets under management decreased by 2% to GBP 108.0 billion - an increase of 6% on a currency neutral basis.

On the banking side things seem to be improving as Impairment losses on loans and advances decreased by 26%. Customer accounts (deposits) decreased by 10% to GBP22.1 billion - an increase of 3% on a currency neutral basis. Core loans and advances decreased by 9% to GBP16.8 billion - an increase of 6% on a currency neutral basis. Loans and advances as a percentage of customer deposits were 72.0% (31 March 2013:71.3%).

The other thing that interests me about this one is that in addition to the benefits of rising markets on their asset & wealth management businesses is that they should also be benefiting form the improving new issues and M & A markets on their Investment banking side. They also seem to be doing some corporate tidying up with proposals to transform its Australian banking business into a boutique operation focusing on Corporate Advisory, Property Funds, Aviation, Commodity and Resource Finance, Project Finance, Corporate and Acquisition Finance, and Financial Markets. Plus an early indication that they are exploring a potential sale of Kensington, the group's intermediary mortgage business in the UK, having received certain expressions of interest. This does not reflect too well on the management though as I seem to remember they bought it in around 2007/8 just before the housing market in the UK peaked out.

So I would suggest it as a contrarian idea as it is emerging market (South Africa / Rand) and financial market exposed, both of which have been falling for a while and recently respectively. In addition as a result, mostly of the Rand effect this one has struggled to grow its earnings in the last five years. Meanwhile since recovering sharply from the 2009 market low (when they cut the dividend roughly in half) the share price has been as flat as a zebra crossing since 2010 despite the strong rise in markets and recovering economies since then.

On the value side of the equation it is flashing some value like a Belisha Beacon with a P/E of 10x to 11x, a yield of around 4.5% which is covered 2x and a price to book of around 1x. There is some growth in earnings and dividends forecast for the next two years but as discussed above this only takes earnings back to where they were in 2010 and the dividend would still be some 4.3p or 17.2% behind the 2008 level.

So if you were prepared to take a contrary view on the Emerging markets and the Rand and believe that markets can continue to rise (but almost certainly slower than last year) and with corporate activity continuing to pick up then this could be an interesting one to look at. I have bought a few on this view and with a price target around last years high of 500p which would be about 25% upside and leave it on around 12x and a 4% yield next years forecast earnings. This does not seem that stretched compared to what Companies with similar business like Close Brothers trade on, albeit without the currency volatility. Failing that at least it looks like it would be a good time to take a holiday in South Africa given where the currency is.

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