Discovery intends to integrate its credit card business, currently operated through a joint venture (JV) with First National Bank (FNB), into its soon-to-be-launched banking offering.
Discovery holds a 74.99% interest in the Discovery Card business with FNB parent company FirstRand holding the remaining 25.01%. The business will be transferred into its bank on the same effective ratio, a Discovery spokesperson told Moneyweb.
Discovery Card has around 300 000 active clients. Its credit loss ratio for the six months ended December 31 2017 stood at 1.5% compared with a market average of 6% for tier 1 credit providers. Profit and revenue increased by 16% and 7% to R207 million and R500 million respectively.
Despite the quality of Discovery Card’s clients, a close of the JV would not have a material impact on FirstRand as only 25.01% of its net profit is reflected in group numbers, said Sam Moss, head of investor relations at FirstRand.
The JV dates back some 15 years. At the time, the insurer was still part of the FirstRand stable and made use of FNB’s platforms and systems to launch a credit card under its own brand.
The proposed purchase of the Discovery-branded FirstRand-issued credit card business and book is subject to approval by the Competition Commission. The insurance group’s banking licence is also subject to conditions related to the shareholding of Discovery Bank. According to the spokesperson, shareholders of the bank are currently discussing how best to manage the conditions, such discussions may potentially impact Competition Commission approval.
“This is a market with a lot of competitors and with incumbents that are very strong… [but] there is a lot of opportunity. We’ve always been an organisation that hasn’t shied away from big competitive institutional business – we entered life insurance at the time when a few big giants existed. [Banking] is a different space and we’ll be tested by our value proposition: will we meet the needs of our clients?” said Discovery chief executive Adrian Gore.
To date, Discovery has spent R1.2 billion on the bank, which is currently functional and being tested by some staff. Total spend is expected to reach R1.5 billion by the launch, expected in the third quarter of the calendar year.
In terms of existing businesses, the group’s performance “surpassed its growth methodology targets”. Established businesses delivered combined growth in operating profit of 15%, compared with a target of CPI +5%, and emerging businesses outperformed their target of CPI + 30%, the group said.
For the six months to December 31 2017, the insurer reported a 19% increase in normalised operating profit to R4.06 billion. Normalised headline earnings rose 30% to R2.83 billion and by 29% to 438.3 cents on a per share basis. The insurance group lifted its interim dividend by 15% to 101 cents.
Renier de Bruyn, an investment analyst at Sanlam Private Wealth, said Discovery is highly regarded due to its innovative management, disruptive products and ability to dynamically underwrite insurance policies and encourage better risk behaviour among policyholders through its shared value business model. But, its weakness lies in its cashflow.
“It is continuously pursuing new business ventures that consume capital while the SA health administration business is the only business in the group that generates meaningful free cash flow.
“Discovery also recognises profit more aggressively than peers, resulting in a large disconnect between reported profit and underlying cash flow. This has resulted in a balance sheet that consists largely of capitalised future income that Discovery has used to offset the cost of writing new business,” he explained.
The group said it generated R6.1 billion in cash. In accounting for tax and finance costs, cash generated is equivalent to R5 billion. Discovery then invested R3.8 billion in new business and R1.1 billion in new initiatives. This, according to De Bruyn, left it with free cash flow of R119 million compared with reported earnings of R2.8 billion.
Shares in Discovery closed 3.13% higher at R182.07 per share.