Grupo Aval Acciones y Valores S.A.

Moat: 1/5

Understandability: 3/5

Balance Sheet Health: 4/5

Grupo Aval is a Colombian financial conglomerate offering a wide range of financial services, including banking, brokerage, and pension fund management.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Grupo Aval’s core revenue comes from its banking operations, with a significant exposure to the volatile Colombian economy, as opposed to diversified businesses like many of its competitors.

Business Overview

Grupo Aval Acciones y Valores S.A., commonly known as Grupo Aval, is a Colombian financial conglomerate. Its operations are primarily concentrated in Colombia and, to a lesser extent, in Central America. It offers a variety of services, including commercial banking, investment banking, brokerage, pension and severance fund management, and the management of financial investment and trust funds.

  • Revenue Streams:
  • The majority of Grupo Aval’s revenue is derived from its four main banking operations: Banco de Bogotá, Banco de Occidente, Banco Popular, and Banco AV Villas. These banks provide services to a large customer base across various sectors.
  • Fee and commission income from its investment banking, asset management, and brokerage segments, together with its trading activity, constitute a significant portion of overall earnings.
  • It also generates revenue through financial advisory services, guarantees, sales and leasing of real estate, and insurance services.
  • Industry Trends:
    • The global banking industry has been experiencing significant shifts, particularly after the financial crisis of 2008 and the recent COVID-19 pandemic. In general, this includes increasing regulations, a greater emphasis on risk management, and a focus on digital transformation.
  • The Colombian banking industry has seen an increase in digital banking adoption and a continued focus on reaching previously unbanked communities.
  • The financial sector in Colombia is also susceptible to macroeconomic factors and the political climate of the region.

  • Emerging markets such as those in Colombia generally provide higher returns on investments than those in developed markets, but at a greater risk. * Banks have been forced to shift their business models due to competition from fintech firms and neobanks, which tend to operate with less regulatory requirements and lower costs than traditional banking players.

  • Margins:
  • Grupo Aval’s net interest margin is heavily influenced by the spread earned on its loan and deposit products, as well as their ability to maintain a high volume of lending.
  • It’s worth noting that, while margins across the banking sector can vary significantly, the company has struggled to compete in fee generating businesses compared to its domestic and regional competitors.
  • Operating margins from fee and commission revenue have generally been higher and less influenced by interest rate fluctuations compared to banking activities.
  • Competitive Landscape:
  • Grupo Aval competes with local banks in Colombia and Central America, as well as internationally operated financial services companies.
  • In Colombia, some of its major competitors include Bancolombia and Davivienda.
  • In some markets, fintech startups and digital banking services pose significant competitive threats.
  • The competitive landscape in the financial sector has been growing increasingly complex with new entrants, new regulations, and changing consumer behavior.
  • What Makes the Company Different:
  • Grupo Aval has a strong presence in the Colombian and Central American markets, giving the firm a regional focus.

  • It controls four major banks in Colombia, providing it with a significant market share, but also causing revenue to be more susceptible to economic fluctuations of the country. * It also has a focus on expanding in the underserved market of microcredit in Colombia.

  • Other Relevant Points
    • The group has a track record of acquisitions, but has not succeeded in creating a positive impact on long term valuations of companies.
    • Management seems intent on reducing leverage in the company as well as increasing dividend pay outs.

Moat Analysis

Grupo Aval’s “moat,” or its sustainable competitive advantage, is rated as 1 out of 5 because it faces significant competitive pressures in the financial services sector, mainly from better-performing banks and other financial institutions and has a very high reliance on the Columbian economy. The company’s main competitive advantages are:

  • Established Regional Presence: As a large financial group in Colombia and Central America with an established presence and a widespread retail network, the company has an edge over new market entrants. This regional dominance and brand recognition could provide a limited moat, but are increasingly under threat from local and international fintech companies with innovative and disruptive technologies and lower costs of operations * Long Track Record: The company has a very long operating history in Columbia, making it a known brand among its citizen’s with a wide portfolio of assets under management. Although these do give it a competitive edge against new entrants, it does not pose a moat against more established players.
  • Diversification of Operations: As a full-fledged financial services company, Grupo Aval has diversified its revenue stream beyond the interest-generating activities of commercial banking. The diversification has its downsides such as diluting management’s focus, but in principle, should help the company become more resilient against risks in a single area. However, other financial services do have their own competitors, and thus, their profitability is not that insulated, causing the moat of these businesses to be weak.
  • “Government’s Darling”: Grupo Aval has had a very good relationship with the governments, which has enabled the company to get favorable treatment. While this has been a plus point for the company until now, it might not necessarily mean that it is a moat. Regulations may and will change, and hence, a reliance on the government for their business can quickly turn into a negative.

The above, however, are not true sources of economic moat. They are just some factors which helped Grupo Aval to build itself into the position which it is in today. True moats rely on characteristics of the business that are extremely difficult to replicate and are structural in nature. Below are the main factors that negatively affect Grupo Aval from possessing a real competitive advantage, and therefore its moat rating:

  • Lack of Differentiation: The banking sector has become intensely competitive. There is little difference in the services offered by most banks; therefore, it has become difficult for traditional banks to maintain or raise prices on their services. Grupo Aval’s banks have to compete mainly based on price, which dilutes the profitability and makes the market very competitive.
  • Highly Competitive Environment: The financial services sector is highly competitive, both in local markets in Columbia and Central America, as well as with international players. This competition is putting downward pressure on fees and interest spreads, leading to lower profitability and eroding any potential moat which Grupo Aval might have.
  • Lack of Economic Moat: Grupo Aval’s main revenue sources have low barriers to entry. The lack of any real competitive advantages gives other firms opportunities to swoop in on its profits and cause profitability to be unstable.

Risks to the Moat and Business Resilience

Several risks could harm Grupo Aval’s business and erode any competitive advantage the company has. Here are some of them:

  • Economic Fluctuations:
    • The Columbian economy has a high volatility. This exposes the company to the risk of higher defaults and lower overall earnings during economic downturns.
    • Changes in local or international interest rates can directly influence the company’s borrowing costs and its earnings from lending activities.
  • Competition:
  • Increased competition from local and international banks, as well as fintech firms and digital banking platforms, may erode the company’s market share and profitability.
  • Fintech startups and digital banking platforms, particularly those with lower cost structures and innovative tech, have gained some market share in a short period of time.
  • Regulatory Changes: Regulatory changes in Colombia and other countries of operation, especially in the financial and tax sector, may negatively impact the company’s profitability and operations.
  • The Colombian government’s policy to tax dividends is likely to hurt overall valuations and profitability of the company going forward. * A significant change in regulation regarding the banking sector, could negatively influence profitability in Grupo Aval’s traditional business.
  • High Reliance on a Single Market:
  • Grupo Aval’s revenue is derived almost entirely from its operations within the borders of Colombia. This highly concentrated approach makes the company susceptible to any negative conditions in the country.
  • Debt Burden: While the company has shown progress in managing it, debt continues to be a major risk for the business.

Despite the risks mentioned above, Grupo Aval has strong historical operations, a diversified business with many sources of revenue, and a strong foothold in the Colombian market. These will help in mitigating risks and allow the company to maintain a somewhat respectable return on investments going forward. Thus, although the company does not have a very strong moat, it is resilient.

Financial Analysis

Here’s an analysis of Grupo Aval’s financials:

  • Net Interest Income: Grupo Aval’s financial performance has been highly influenced by its net interest income. The company generates a significant portion of its revenue from loans and mortgages, which is highly correlated with local interest rates, which in turn, depend on the economic and political climate of Colombia.
  • The company has been successful in controlling its expense margins and has consistently shown positive interest income.
  • Fees and Commission Income: Although Grupo Aval’s main revenue segment is its lending operations, the company has shown good performance in fee generating operations. These include brokerage, investment banking, and asset management related services, which are relatively stable compared to the lending business.
  • Operating Expense: Grupo Aval has been successful in controlling its operating costs and maintaining them at a modest level. However, the company’s heavy reliance on banking operations has made the company more vulnerable to operational costs of the traditional banking model.
  • Net Profit: The company has had a volatile profit performance over the past few years as margins and earnings were hurt by a variety of factors such as rising inflation, higher interest rates, and a slowdown in economic activity.
  • Return on Equity (ROE): The company has consistently had a return on equity of around 10%, which is somewhat below average for financial companies. As mentioned previously, ROIC and earnings are closely tied in this company, meaning that a higher profit may or may not translate into a higher ROIC.
  • Balance Sheet: Grupo Aval has a stable liability position, which includes significant amounts of customer deposits, providing it with a low cost of capital for operations. However, a large proportion of its total assets are composed of loans to clients, and this makes the company particularly susceptible to economic fluctuations.

While the company is mostly profitable and has displayed adequate solvency, its financials are volatile and closely tied to the Columbian economy, which makes its performance unreliable, and makes its operations more risky.

Understandability

Grupo Aval’s business is rated 3 out of 5 in understandability because it is moderately complex to understand, but not very easy. Here’s why:

  • Complexity of Financial Services: Understanding financial services, in general, requires some level of financial literacy. Grupo Aval is a financial conglomerate with various subsidiaries; therefore, understanding how these businesses operate individually, and in combination with one another, can be difficult for people without a background in finance.
  • Regulatory Environment: The Colombian banking industry is regulated, with various rules and guidelines impacting the company’s operations. Keeping up with all these rules and accounting standards requires significant analysis and is more complex to navigate.
  • Reliance on the Economy: Grupo Aval’s performance is largely dependent on the Colombian economy and its political environment, therefore, to fully understand the company, the investor needs to have a detailed knowledge of the environment it operates in. This complicates its business operations and requires deeper thinking.
  • Diversified Revenue: Grupo Aval makes revenue through multiple avenues, this adds an extra element of complexity into evaluating the business.

Balance Sheet Health

Grupo Aval has a reasonably strong balance sheet, and therefore, it is rated 4 out of 5 for balance sheet health. This is due to the following points:

  • Adequate Liquidity: Grupo Aval has adequate liquidity, as demonstrated by a large and stable customer deposits base. While high, it is required to serve as capital for all its business operations, including lending, and therefore, can not be regarded as pure liquidity.
  • Reasonable Solvency: It’s well capitalized, which limits the possibility of a liquidity crisis.
  • Acceptable Leverage: The company’s leverage ratio has come down in recent times, which has made the business more financially stable.
  • Debt Burden: Its debt remains high and continues to pose significant risks, but management has given indications of reducing this and creating a healthier business in the long term.

Recent Concerns / Controversies

  • Increased Regulations Since 2022, some regulatory changes were made in Colombia, particularly in relation to taxes on dividends, which would negatively affect the profitability of the company and its ability to pay dividends to its shareholders, and this could lower the value of the company’s equity. Management is focused on implementing new strategies to help offset this negative effect, while maintaining a positive view of the future.
  • Economic Downturn In early 2023, the Columbian economy showed signs of slowing down. This has had a negative effect on the company’s credit quality, as loan defaults increased slightly. Management have been quick in response and set up stringent measures to mitigate this effect. They expect things to get better over time and are hopeful of future returns.
  • Share Dilution While the company has bought shares of some subsidiaries to strengthen their performance, and to protect shareholders in the event of a sale, they may not have provided the best value to the investors, as these acquisitions have been dilutive to existing shareholders. Management, however, believes these actions to be extremely important for long-term sustainability and value creation.
    • Lower Returns: The company, in recent years, has failed to produce returns that would compete favorably to other similar financial companies. Management hopes to make good on this going forward, and that it is in the process of improving operations and focusing on increasing profitability, while focusing on lowering capital expenditure.
  • Changing Landscape: The changing landscape of the banking sector may negatively affect the earnings of Grupo Aval and traditional banking businesses, as new technology-based companies create new and cheaper ways to offer similar services. Management has taken notice of this and has set up an extensive digital transformation division to help compete with new firms, while focusing on its core business.

Overall, there is no evidence that Grupo Aval is building a truly sustainable moat and the business faces several risks which could harm it. The company needs to focus on improving profitability and operational efficiency to become a better competitor in the industry, while being able to weather any storm the Columbian economy faces.