ABIL trading update jolts market

On Thursday just after the market closed African Bank came out with trading statement which said that the company is expecting earnings to fall by between 25% and 28% relative the comparable 170,4c for the 6 months ending 31 March 2012. This caused the stock to collapse 17.5% on Friday and down again today, 3.7% so far. As one of our core recommended stocks this of course reason for major concern.

"The first half of the 2013 financial year was a challenging period. The Banking unit showed positive advances growth and maintained good control over operating and funding costs. These improvements were however negated by:

A lower yield, partially as a result of higher suspension of interest and fees;

An elevated charge for bad and doubtful advances, particularly on the furniture credit portfolio, as a result of higher provisions due to an increase in risk; and

Substantially increased insurance claims and provisions resulting from the group broadening the range of insured events."

With the risk of trying to put lipstick on a pig let us delve into the details. Since September 2008 the company has grown earnings from 210c to 341c in September last year. That is an annual average growth of 13.1%. The fast half of last year where the business made 170.4c was the best half the company has ever had and is more than what the company made in the whole of 2004. This is of course the period we are comparing these numbers against.

As you can see from the extract above, advances are still growing, what has hit earnings so hard was ABIL's decision to write off an additional amount of non-performing loans. We had a chat to management about this and can confirm what we already suspected. The company is being extra conservative here, aggressively writing off bad debt so as to prepare for the worst. Clients in this category who end up repaying these loans will be a bonus.

So why has the share price reacted so badly? The unsecured credit market has been in the spotlight for a while now. Since Basil 3 came out with strict capital requirements the big 4 banks in South Africa have been flying into the unsecured market because returns were so much higher than their usual collateralised lending. This of course saturated a market where Abil have been first movers. Abil, having full exposure to this market with very little diversification were the perfect entry to short the unsecured market. Management had also painted a picture that everything was under control and this news surprised the market which is never a good thing.

If earnings were to drop let's say 23% for the full year on the basis that the second half will be slightly better than the first, then we should see full year numbers at around 260c. For a stock now trading at R23 that is forward PE of 8.8 and a forward dividend yield of over 6%. But it is of course the future that is important, here is their outlook.

"Outlook for the remainder of the financial year For the Banking unit, the group anticipates that the reduction in yield will normalise in the second half of 2013. The bad debt charge is expected to remain elevated for the rest of the year, but the risk reduction measures will benefit the charge from 2014. At the same time, the increased write-offs have improved the quality of the remaining NPL portfolio. These trends, complemented by continued growth in advances, new products, as well as innovations in the group's offering, provide a solid underpin for the business over the medium term."

What to do? There is no doubt we have called this one wrong, admitting your mistakes is a very important part of investing. But I do believe the stock is grossly oversold, the shorts are making bucks and at some stage these will need to be covered and we should see a spike in the price. That does not mean it will reach over R30 in a while. We are analyzing this one closely and will send some more analysis during the week. For now we will hold.