Financial market analyst Jeremy Grime comments on Growth and Bank of Georgia

19 February 2019

 I find myself dreading the newspaper headlines surrounding Greggs strong trading statement on the back of their launch of Vegan sausage rolls today.

The Growth Fallacy 

• Many times companies have put their case that their rating is too low given the earnings growth. When the reality is that EPS growth is less a determinant of rating than operating margin, certainly in the financial space. The chart below shows for companies involved in the wealth management supply chain a 42% R squared correlation between margin and PER while the EPS growth R squared is 5%. 

• Interpretation Companies with a data point above the line represent those with a high PER compared to the operating margin so are either more highly valued earnings streams or are anticipating an improvement in profits. Companies below the line have a low PER relative to the operating margin so either the market anticipates a decline in profits or the earnings are of lower quality or alternatively the shares are undervalued.

 

• Results

 

Platforms It is noticeable that all the companies above the line are platform businesses.  These have very sticky customers and high margins due to the scale benefits that provide for high margins but they also have fee pressure.  When the third of these three factors becomes more dominant they will not be the companies above the valuation line of best fit.

 

Wealth Managers Brewin, Rathbone and Quilter are all well below the line.  These companies all have sticky customers but margins are lower as staff take more of the revenues than is the case for platforms and there is the risk of staff walking out with customers.

 

AFH is looking cheap – potentially there may be a perceived risk of an equity placing to fund the on-going acquisitions

 

Tatton Investment Management looks cheap

 

Jarvis is a very high ROCE business but is undergoing a phase of investment resulting in lower revenue per employee which if this is just a period of investment means it is temporary. Though the company is largely family owned and so liquidity is low and little resource is directed towards investor relations.

 

Bank Of Georgia – FY Results 

Share Price 1725p

Mkt Cap £822m

 

• Results Profit was up 23% year on year to GEL 493m with a 26.1% ROAE achieved in 2018. The Basel 3 Tier 1 ratio is now 12.2% and the loan book growth was 21% during the year of which close to 70% is retail. Cost of credit was 1.6% down from 2.2% in 2017 and continued to decline over the year while net interest margin was a healthy 6.5% while the cost income ratio was 36.5%. Additional regulation has meant that this bank which traditionally has targeted 20% ROE, 20% growth and 20% Tier 1 is today moderating expectations to 15% lending growth as the lending will now move more towards corporate and mortgage and away from retail.

 

• Estimates The GEL 1,030m of revenue looks a little shy of the GEL 1,087 estimate although the net income of GEL 380m is ahead of the GEL 364m estimate. Forecasts are predicated on 13% revenue growth so with reducing cost of credit look reasonable.

 

• Valuation The company has delivered 26% ROAE and trades at 1.6X book value.  In PER terms this is 5.5X with a 5.2% yield

 

• Conclusion When this company came to market the targets were 20% leverage, 20% growth and 20% ROE. It is now delivering the 20% ROE but at the expense of leverage which is now considerably higher than the 20% and growth expectations have now moderated to 15%, which is the sign of a company maturing.  With an economy growing at 4.8% it should continue to produce stronger returns than most other UK bank stocks so is perhaps one to own.  But banks are a declining part of the UK stock market. In 1913 around 50% of the UK market was made up of railway stocks but the fact that banks have been a large part of the UK market in the past doesn’t meaqn they need to be going forwards.