Improved Eskom Operations Expected To Positively Impact South African Economic Activity

Key Takeaways

• A unified retail franchise strategy and productivity improvements through technology are expected to drive medium-term earnings growth and enhance net margins.
  
• Growth in non-life insurance and recovery in lending businesses are set to diversify revenue and improve net interest margins.
  
• Geopolitical tensions and economic challenges may compress margins, affect currency stability, and impact revenue, necessitating cost optimization to achieve earnings targets.

Catalysts

Provides retail, business, corporate, investment banking, insurance, financial, and wealth management products and services in South Africa and internationally.

• The improvement in Eskom's operational performance and stable electricity supply is expected to positively impact South Africa's GDP growth projections, potentially boosting overall economic activity and increasing revenue generation for Absa Group.
  
• The strategic shift towards a unified retail franchise in South Africa is anticipated to enhance cross-selling opportunities and improve revenue trends, thereby supporting better medium-term earnings growth.
  
• The focus on productivity improvements through technology and cost optimization is projected to yield substantial savings, which can be reinvested to drive growth, thereby enhancing net margins and contributing to a higher EPS.
  
• Growth in non-life insurance driven by process optimization, better claims experiences, and increased cross-sell opportunities is expected to contribute to revenue diversification and improved overall earnings.
  
• The recovery in lending businesses and easing credit impairments in key sectors like Vehicle and Asset Finance and Home Loans are likely to drive earnings growth and improve net interest margins in the medium term.

Absa Group Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Absa Group's revenue will grow by 11.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 22.5% today to 21.6% in 3 years time.
• Analysts expect earnings to reach ZAR 28.2 billion (and earnings per share of ZAR 34.78) by about August 2028, up from ZAR 21.5 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 10.6x on those 2028 earnings, up from 6.9x today. This future PE is greater than the current PE for the ZA Banks industry at 7.7x.
• Analysts expect the number of shares outstanding to grow by 0.08% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 19.31%, as per the Simply Wall St company report.

Absa Group Future Earnings Per Share Growth

Risks

• Geopolitical tensions and the Ukraine-Russia war could adversely impact Absa's operations and currency stability, affecting revenue and earnings.
  
• Strained relationships between the U.S. and South Africa pose risks to the rand, potentially impacting investment and economic growth forecasts, thereby influencing Absa's revenue and profitability.
  
• Elevated cash reserving requirements in countries like Ghana, Zambia, and Mozambique could compress net interest margins, negatively affecting net interest income.
  
• The potential need for further cost optimization and productivity gains may indicate underlying cost pressures, which, if not managed well, could impact net margins.
  
• Ongoing macroeconomic uncertainties, including lower than expected South African GDP growth, could jeopardize revenue projections and constrain Absa's ability to achieve earnings growth targets.

Valuation

• The analysts have a consensus price target of ZAR211.252 for Absa Group based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ZAR241.85, and the most bearish reporting a price target of just ZAR180.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be ZAR130.6 billion, earnings will come to ZAR28.2 billion, and it would be trading on a PE ratio of 10.6x, assuming you use a discount rate of 19.3%.
• Given the current share price of ZAR177.99, the analyst price target of ZAR211.25 is 15.7% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.