Compared to even 5 years ago, there are some really excellent online resources for UK investors. Of course there is Sharepad (which you can subscribe to through this link here) Another one is Mello Events, where David Stredder asks interesting companies, fund managers and other speakers to talk about investment. The evening finishes with a semi-competitive “BASH” (Buy Avoid Sell Hold) in which different speakers battle it out with their best stock ideas – trying to pitch their idea, and perhaps make a couple of friendly but critical comments on the other speakers’ ideas. This isn’t supposed to be investment advice, just a fun way to end the evening, and hopefully a catalyst for further research among the audience.
Below is the text from my Bank of Georgia pitch. I own the shares, so I’m talking my own book – but that also means that these aren’t just empty words, I have skin in the game. 10 years ago I listed the bank on the London Stock Exchange. Back then I suggested that compared to UK banks, BGEO was the lowest risk bank on the LSE. 10 years on, here is my updated investment case:
Value and Quality
I’m going to present a really contrarian idea. It’s a value stock, because it’s trading on 5x earnings. That said, it’s also a quality / growth stock because it’s reported a Return on Equity of between 15-25% over the last 10 years, and it has grown at around 10-20% a year.
But there is a reason that the company is so cheap: it’s in a hated sector; not just that, it’s in a part of the world where countries have a peculiar habit of invading each other. The bank is listed on the London Stock Exchange (premium listing, not AIM) but lends money in a small mountainous country of around 4m people, where they speak a funny language, with a decent rugby team, no –I’m not talking about Scotland (they obviously don’t have a decent rugby team) – I’m talking about Georgia. And the stock is Bank of Georgia.
Everyone hates banks
Let’s talk first about why the banks sector is so hated. Everyone hates banks, customers hate banks, employees hate banks, politicians hate banks, regulators hate banks, shareholders hate banks because they’ve been terrible investments for the last 20 years. Obviously Northern Rock and Royal Bank and Lehmans failed and shareholders were wiped out, but even the so called “quality banks” like Lloyds, Standard Chartered and HSBC have been terrible investments –the best of the bad lot are trading close to 25 year lows.
The reasons why is that there’s been a huge build up in debt / GDP across the world, by 2009 UK bank asset were 5x GDP. Despite lending all this money, banks top line didn’t grow very fast because their net interest margins fell, though Return on Equity stayed the same.
Return on Equity
There are only two ways that you can report a high Return on Equity
- make the numerator, the “returns” high
- make the denominator low, make the “equity” funding low
Ahead of the financial crisis UK banks were reporting 20% plus RoE, but they were doing that with wafer thin Net Interest Margins (just 1% NIM in the case of Northern Rock). So to report a high RoE, banks mis-sold Payment Protection Insurance (PPI) and shrank their equity funding as a percentage of their liabilities, until we had the banking crisis. Then after the financial crisis banks stopped selling PPI, and the regulators forced them to increase the denominator again. The “equity” of RoE had to rise, but net interest margins didn’t rise, so it’s no wonder RoE has been very disappointing in the UK. All this was obvious 10 years ago. But professional fund managers don’t tend to react well to anyone who points out flaws in the investment case of assets they are holding. Such a psychological bias goes back in time at least as far as Laocoön suggesting that perhaps it might not be a good idea to bring the wooden horse left by the Greeks inside the city gates of Troy.
Lending money is a commodity business, banks try to pretend that they have brands and they have adverts with black horses or sponsoring the cricket or this “It’s not all work, work, work, ya know”
– and that’s how they generate high returns on equity. Of course, it’s all nonsense; brands don’t work in banking – no one says “oh, I’d like to borrow hundreds of thousands of pounds to buy a house, and banks A offered me the best interest rate, but I’ll go with the more expensive loan from bank B, because I like the marketing”. I don’t think so!
Bank of Georgia
So that’s true for banks in general, but let’s talk about Bank of Georgia. GDP per capita in Georgia is around $5000, and mortgages to GDP are around 15%. BGEO’s assets are 9x larger than equity, now that sounds like a lot compared to an industrial company, but BARC total assets are 20x larger than equity, and before the financial crisis were over 40x larger than equity. So the Georgians bank’s balance sheet is much better shape than UK banks, and their customers are less indebted.
Pre-Covid Bank of Georgia was reporting a RoA above 3% FY 19 compared to just 0.3% for Barclays and Lloyds FY 19.
Brands and advertising don’t make a difference to bank returns. But what does make a difference to bank returns is market share, and generally it’s much better to be a bank in a small fast growing country with a concentrated marketshare (think Singapore or Hong Kong Banks) than a bank with a big market but a small market share (eg German banks). It doesn’t always work (eg Irish banks!) but it’s a good rule of thumb to invest in banks with fast growing concentrated market.
In 2020, Georgia GDP was down 6%, but before then real GDP was growing at real CAGR of around 5% a year and is forecast to return to that 5% real trend growth rate.
So Bank of Georgia has a 1/3 market share, which means the high returns on equity of 20% are more likely to be sustainable, plenty of room to grow at 15% a year. In Georgia there is no equivalent of HBOS or Northern Rock, funding dumb loans through the securitisation market, or landesbanken in Germany funding dumb loans which until recently were backed by the state.
So I think the risk of investing in BGEO are lower than most Western banks. There is always credit risk with banks, but the risk of competition forcing BGEO management to make bad loans is less than in Northern Europe. And the shares are trading on 5x earnings, so I think over the next few years you should see earnings much higher, but hopefully also some multiple expansion as investors reward the bank with a higher rating.
The bank reported FY results at the end of February. I wrote them up in more detail at Sharepad. You can subscribe through this link here