Capitec’s rise from challenger to champion

Capitec continues to take market share from its established competitors, with its differentiated strategy and operating model enabling it to legitimately challenge South Africa’s ‘Big Four’ banks. 

The Big Four of Standard Bank, Absa, FirstRand (FNB), and Nedbank have long dominated South African banking, commanding most deposits and advances. 

However, Capitec has emerged over the past two decades to become a genuine challenger to these four banks. 

In a recent research note, Chris Steward, Sector Head of Financials, SA Equity & Multi-Asset at Ninety One, outlined why Capitec has grown so strongly and how it has disrupted its established peers. 

At the heart of Capitec’s evolution has been the firm’s ability to identify areas of the market that are both lucrative and ripe for disruption – and then target those areas with precision, Steward said. 

“We believe that Capitec fits firmly within this framework and is well-positioned to continue its current growth trajectory, making it our preferred banking stock within the Ninety One SA Equity and Multi-Asset Strategies,” he said. 

One of Capitec’s defining features is how conservative the business has been during its developmental phase, particularly in how it has managed its capital. 

For example, the bank’s capital adequacy ratio (which measures how much capital a bank holds in relation to risk-adjusted assets), is around 37%, which is significantly higher than most South African Tier 1 banks at around 12-13%.

Its liquidity buffers tell a similar story. While most banks use the money from short-term savers to fund longer-term lending activities, retaining a relatively small portion for liquidity purposes, Capitec maintains a liquidity buffer of around 100%. 

This means it could meet all its short-term liabilities through a combination of cash and other highly liquid instruments. 

Despite holding more capital than any of its peers and taking this conservative stance on liquidity, Capitec has the highest return on equity of any bank in the country. 

This demonstrates its effectiveness in deploying capital and also gives the bank greater opportunities to generate higher returns over time or return more value to clients.

How Capitec became a giant

Capitec’s ability to identify and target opportunities ripe for disruption has characterised its growth into a banking giant. 

Early on, the bank decided to diversify away from unsecured personal lending towards retail transactional banking. 

At the time, most savings and transactional accounts were dominated by the Big Four and characterised by high fees, inflexible service and little interest paid on credit balances.

Capitec identified this as an opportunity to offer consumers a simple transactional banking offering, delivered at an exceptionally low cost, leveraging its lack of legacy constraints, Steward explained. 

This enabled Capitec to compete on transactional costs and offer clients competitive interest rates on retail deposits.

After complementing its transactional offering with a credit card, Capitec’s next move saw it diversify into insurance. 

The bank launched funeral insurance with Sanlam in 2018 as a value-added service, with the plan to eventually build its own in-house capability. The arrangement with Sanlam is set to terminate later this year.  

In 2019, Capitec purchased Mercantile Bank to develop its in-house business banking capability, with the bank targeting businesses that were too small to fit into a typical corporate banking framework. 

By offering business banking at a lower cost and focusing on point-of-sale, Capitec is acquiring business clients while better understanding their transactional activities and cash flows. 

Steward said another area where Capitec excels is its ability to use client data to better understand client needs and behaviour, improve the overall experience, and cross-sell its products. 

As shown in the graph below, the transactional side of Capitec’s business continues to grow exceptionally well. Its retail transactional income now accounts for over 136% of the bank’s cost base. 

This is hugely significant for investors, as this side of the business requires substantially less capital.

A legitimate challenger

Looking at the South African retail and business banking revenue pool over the past 14 years, Capitec’s market share increased from around 3% to around 14%. 

Given its low-cost, purpose-built business model, its profit share has grown faster, from around 4% to almost 20%. 

Despite growing its market share by almost five times, Capitec remains the smallest bank in the country in terms of market share of retail and business banking revenue. This presents a significant opportunity, Steward said. 

From having around 250 branches and very few ATMs in 2005, Capitec has grown to nearly 900 branches, with the highest number of ATMs across South Africa, at almost 9,000. 

This expanded presence comes at a time when most other banks are desperately trying to reduce costs, opting instead to lower the number of physical branches and ATMs that they have around the country.

Steward explained that the consensus among most investors is that Capitec’s share price is too expensive. 

South African banks typically trade at a P/E of around 6 to 10 times and dividend yield of 5 to 7%. Capitec, meanwhile, trades at more than a 20x P/E and a dividend yield of only 2%. 

The reality, however, is that the bank has always traded at a high valuation. 

As with all growth companies, it is essential not to look at valuations in isolation but rather in the context of the company’s sustainable future growth.

“We believe Capitec has a compelling growth story and has consistently delivered exceptional value for shareholders despite always screening as relatively expensive.” 

“Given the company’s proven track record and long-term ambitions, we believe its growth story will continue to play out and that its earnings growth will more than compensate investors for higher valuations.”