EPU - Mixed Economic Signals Holding Back Peru's Intercorp

2023-08-11 12:11:09 ET

Summary

• Intercorp Financial Services is a significant player in the Peruvian banking industry, but has struggled as a public company.
• The company has $23 billion in total assets, generated $438 million in net profit last year, and offers full-service banking, insurance, and wealth advisory.
• Intercorp's Q2 results showed modest growth; near-term political and economic challenges are likely to constrain the upside through the rest of 2023.

Intercorp Financial Services ( IFS ) is one of Peru's primary banking companies. It is much smaller than Credicorp ( BAP ), which is the market leader, but Intercorp is right there in the next tier of significant industry participants.

Intercorp completed its U.S. IPO in 2019. This ended up not being especially auspicious timing. The pandemic started not long after, and Intercorp stock plunged in the wake of that. Then, Peruvian political drama added to the poor sentiment around its equities, including Intercorp, in 2021. All told, Intercorp has not had a particularly impressive run as a public company, and its shares have failed to attract much interest or trading volume in the U.S. to date.

With shares not that far off their historical lows, even as Latin American stocks are starting to catch a bid this year, it's time to take a deeper look at Intercorp.

Intercorp's Place In The Peruvian Market

Intercorp is a holding company that operates Interbank along with other properties. Intercorp was founded in 1994 when its backers purchased Interbank from the Peruvian government and set about to grow it as a private sector enterprise. Interbank achieved rapid growth through partnerships with distribution channels such as supermarkets, and the firm soon also went into real estate. It has since branched out broadly from there.

In less than thirty years, Intercorp has grown into being one of Peru's most important financial institutions.

From a recent corporate presentation, here are key points for Intercorp:

Intercorp has a sizable $23 billion in total assets as of year-end 2022. This comes well short of Peru's largest bank, Credicorp, which had $65 billion in total assets at year-end 2022. However, $23 billion is a respectable number by Latin American banking standards, and it is certainly enough for the firm to achieve economies of scale.

Intercorp generated $438 million in net profit last year, and delivered an exemplary 17.7% return on equity. The 36% efficiency ratio is also one of the best within my coverage universe of banks.

Intercorp is full-service, offering banking, insurance, and wealth advisory. While it isn't #1 in most verticals, it ranks within the top three across the board. It also has its Izipay point-of-sale platform, which allows merchants to accept payments from debit and credit cards and mobile wallets.

Intercorp's 2023 Results

Intercorp's Q1 results, from earlier this spring, were fairly underwhelming. While the bank enjoyed strong increases in rates on its lending, this was offset by a sharp increase in its cost of deposits. Inflation ran hotter and longer in Peru than expected, causing rates to continue rising, perhaps past where local analysts had been modeling.

On top of that, the ouster of the former Peruvian president in late 2022 and associated social unrests and road blockages tied to that caused a sharp near-term dip in Peru's economy, and thus Intercorp's results, early in 2023. It's notable that key tourist sites, such as Machu Picchu, were largely closed for several months as a result of the upheaval, thus hurting key segments of Peru's hospitality sector. In addition, road blockades caused several mines to suspend operations for a time due to being unable to export goods in a timely fashion.

However, most of these issues cleared up by about February, meaning that Peru's economy was expected to pick up steam as the year progressed. This would, hopefully, make itself apparent in Intercorp's Q2 results.

In reality, however, Peru's economy hasn't quite accelerated as expected. It returned to marginally positive GDP growth by April. But May shocked analysts with an unexpected 1.4% decline in Peruvian GDP year-over-year. Unfavorable weather slammed agriculture and fishing. Manufacturing and construction were also down meaningfully. The copper mining sector is growing vigorously, but it wasn't enough to offset the weakness elsewhere.

On the political front, while Peru's swing from a self-avowed communist president to the current right-of-center president has been favorable for business, the present leader is quite unpopular and uncertainty remains about her capacity and mandate to rule. While Peru's overall economic situation is brighter than it was a year ago, the unfavorable climatic effect of El Niño, an unsettled political situation, high interest rates, and continued reluctance to invest in new construction and industrial projects are all weighing on Peru's economic outlook.

These mixed economic winds were reflected in Intercorp's Q2 results, which were released on August 9. Loans grew 5% year-over-year and just 1% versus the first quarter of this year. Deposits fell 2% between Q1 and Q2. Overall profits were up in large part due to rising interest rate yields on its loans, along with improved results from the wealth management sector thanks to the rise in global equity markets. That said, Intercorp saw its impairment losses on loans rise by 13% as the lingering weakness in the Peruvian economy started to make itself felt in the bank's loan book.

The bank's earnings results were by no means bad -- Intercorp is playing its hand reasonably well. However, these results once again failed to excite the market; IFS stock fell 3% following the release of this latest earnings report.

I remain upbeat on Peru in the bigger picture thanks to its favorable fundamentals. It has reasonably strong institutions and legal protections by Latin American standards, and its current president is far more business-friendly than Peru's prior leader. As Peru is heavily reliant on exports such as copper and gold for economic activity, it should fare well in the current inflationary environment. The copper sector, in particular, should prosper thanks to the rising demand from renewable energy and electric vehicles.

That said, my view on the Peruvian economy has turned less optimistic in the intermediate-term. Things were supposed to have fully kicked back into gear by mid-summer. Instead, the latest Peruvian GDP report was far short of expectations and spoke to significant structural issues. Peru's economic recovery may now be a 2024 story. And that possibility itself is contingent on the rest of the world not falling into a recession by then. All this to say that banks like Intercorp and Credicorp will now be hunkering down for a few more quarters instead of enjoying a rapid economic upswing.

IFS Stock Verdict

I view Intercorp shares favorably here, in that I expect them to outperform the market going forward. That said, I don't own any personally. That's because I see rival Credicorp as a superior long-term investment . Credicorp has more operating scale, a longer track record on public markets, and its fast-growing digital wallet platform.

Over the past year, Credicorp has produced a 22% total return. The iShares MSCI Peru ETF ( EPU ) is up even more, while Intercorp has lagged both of those alternatives significantly.

The bulls would argue that there is room for Intercorp to make up that underperformance versus Credicorp and the Peruvian index. JPMorgan, for example, recently started coverage of Intercorp with an overweight rating noting that the bank benefits from anticipated interest rate cuts as it has more exposure to fixed rate loans. Additionally, Intercorp recently started a share buyback program.

So, there is a reasonable case for Intercorp. That said, in my view, the easiest way to express a macro bullish view on Peru is by owning Credicorp, the much larger bank. Credicorp's leading mobile wallet ecosystem is a particularly good hidden asset within that overall business.

And finally, with the political tailwinds not blowing as strongly as I had previously expected, there is a case for near-term caution on Peru overall. I wouldn't be surprised if Peruvian stocks trade flat for the rest of the year before starting to rally again in 2024. As such, I'm fairly ambivalent on Intercorp today, though with a lean toward a buy rating. I see the long-term appeal and expect investors to make money in due time. But I like Credicorp better, and I also have some near-term concerns around the Peruvian economy and political environment that constrain my bullishness a fair bit.

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