Mid Market Expansion And Wealth Management Will Drive Long Term Earnings Upside

Catalysts

About Investec Group

Investec Group is a specialist banking and wealth management group focused on select private, corporate and mid-market clients in South Africa, the U.K. and internationally.

What are the underlying business or industry changes driving this perspective?

• Expansion of the South African commercial and corporate mid-market franchise, with a targeted tripling of client numbers and higher product penetration per client, should drive sustained loan growth and capital light fee income, supporting revenue and return on equity.
• Scaling transactional banking and operational deposit gathering in both South Africa and the U.K. is improving the funding mix away from wholesale deposits. This should lower the cost of funds and underpin net interest margins and earnings resilience.
• Ongoing modernization of technology platforms, including API enabled integration, automated onboarding and higher software capitalization, is expected to reduce run rate operating costs over time and improve scalability, supporting the cost to income ratio and net margins.
• Growth in wealth and investment businesses, supported by rising assets under management, record inflows and the Rathbones synergy program, increases non capital intensive, non interest revenue, which should stabilize group earnings and enhance return on tangible equity.
• Gradual normalization to a lower interest rate environment, combined with stable asset quality and credit loss ratios already within through the cycle targets, is likely to reduce impairments and support client activity, benefiting net interest income, fee income and overall earnings.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Investec Group's revenue will grow by 10.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 31.9% today to 29.6% in 3 years time.
• Analysts expect earnings to reach £783.2 million (and earnings per share of £0.87) by about December 2028, up from £633.7 million today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 12.1x on those 2028 earnings, up from 7.1x today. This future PE is greater than the current PE for the ZA Capital Markets industry at 9.0x.
• Analysts expect the number of shares outstanding to grow by 0.32% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 21.96%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• A prolonged period of lower global and domestic interest rates may weigh more heavily than expected on Investec Group's endowment and surplus cash income, which could offset loan book growth and pressure both net interest income and overall earnings.
• If competitive dynamics in South Africa and the U.K. mid-market force Investec Group to defend or win business at thinner spreads, the combination of lower pricing and rising fixed costs ahead of inflation could compress net interest margins and reduce net profit margins.
• The heavy, multiyear investment in technology modernization, new platforms and additional headcount may take longer than planned to deliver efficiency gains, leaving the group with structurally higher operating expenses and a weaker trajectory for cost-to-income and earnings growth.
• Expansion into the corporate mid-market, a segment acknowledged to carry higher impairments in exchange for higher yields, could expose Investec Group to cyclical credit shocks or sector-specific stresses, resulting in a sustained uplift in the credit loss ratio and lower net earnings.
• A slower-than-anticipated improvement in U.K. macroeconomic conditions and ongoing policy and fiscal uncertainty could limit client activity and fee generation, undermining the plan to grow non-interest revenue and restraining return on equity at both the U.K. business and group level.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of ZAR136.01 for Investec Group based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be £2.6 billion, earnings will come to £783.2 million, and it would be trading on a PE ratio of 12.1x, assuming you use a discount rate of 22.0%.
  
• Given the current share price of ZAR119.27, the analyst price target of ZAR136.01 is 12.3% 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.