Intercorp Financial Services Inc

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

Intercorp Financial Services Inc. is a diversified financial services company headquartered in Panama. Its operations span banking, insurance, wealth management, and related financial services primarily in Peru.

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.

IFS provides a range of services, including corporate banking, retail banking, wealth management, consumer finance, brokerage, and insurance, making it a diversified financial services group.

Business Overview

Intercorp Financial Services Inc. (IFS), primarily based in Peru, operates in four key segments:

  • Banking: This is the largest segment of IFS, and it includes a wide range of financial services, including loans, deposits, and other banking products for individuals and businesses.
  • Insurance: IFS offers various insurance products, including life insurance, annuities, property and casualty insurance, and workers’ compensation insurance, catering to individuals and businesses.
  • Wealth Management: This segment provides asset management services, portfolio management, and financial planning for high-net-worth individuals and institutional clients.
  • Financial Services: The remainder of IFS’s activities are grouped together in this segment and primarily includes brokerage activities, and financial and payment solutions for the group’s various businesses.

While IFS is headquartered in Panama, most of its operations are in Peru, which is why it should be assessed as a Peruvian financial stock.

  • Geographic Distribution: The majority of the company’s revenue is from Peru, but IFS also has operations in other countries, including Panama and neighboring countries. There are some intercompany transactions, which are eliminated in their consolidated accounts.

  • Industry Trends: The Peruvian financial sector has demonstrated a relatively high growth in recent years, driven by the country’s emerging middle class, and increasing access to credit. There is strong growth potential in wealth management and financial services sectors. Competition in the sector has been increasing in recent years due to both consolidation within the industry, and entry from new foreign and domestic players. The banking industry is also seeing changes due to an increase in digital payments, more online services and greater access to financial services for the population.

New tech developments (such as FinTech) are increasingly influencing competition in the banking industry.

  • Competitive Landscape: While IFS enjoys a leading position in Peru, it faces competition from both domestic and international banks and financial services companies, and competition with other insurers. In banking, it competes with strong banks like Credicorp, BCP, etc., and also faces increasing competition from fintech startups. In insurance, local and international insurance companies are competitors and this has resulted in intense competition. In wealth management, it faces challenges from well-established global players and also local players with strong brands, and there are many competitors that offer payment solutions.

  • What Makes IFS Different: The company emphasizes its presence as an integrated financial services provider, with strong connections and a solid brand. The company also emphasizes its focus on innovation and technology in its operations. Their multi-segment approach also differentiates them from monoline businesses.

Financials

  • Revenue Distribution: In 2022, interest income and similar items were the largest part of the group’s income at 62%, followed by fees from financial services and insurance premiums. The wealth management segments is a small part of their revenue.

  • Growth: In the last 3 years, there has been a strong trend of growth in interest income, while the net income from financial services and net insurance premiums have been more volatile.

  • Profitability and Margins:
    • In 2022, net profit was 23.3% of total operating income (the sum of all revenues)
    • From 2019 to 2022, net interest margin fell from 6.9% to 5.4%. This is attributable to both an increase in interest expenses and a decline in net interest income.
    • From 2019 to 2022, the net insurance margin decreased from 8.6% to 3.5%. This is attributable to increased expenses related to claims and benefits and lower operating revenues.
    • For wealth management and financial services, there are no operating margins because costs are difficult to separate from their revenues.
  • Balance Sheet:
    • The balance sheet is conservative.
    • Long-term debt is very low at $5.1 Billion, and 28% of the total capitalization is through equity.
    • Cash and cash equivalents are at $8.1 Billion, providing enough liquidity.
    • However, the main portion of their debt consists of debt from interbank loans that are very short-term in nature-less than a year. The loans portfolio also includes significant amounts of loans that are more vulnerable to economic downturns.
    • They also have a relatively high amount of goodwill and other intangibles, which makes the assets less tangible.
  • Recent Concerns and Controversies:
    • High competition in the banking sector and rising costs are a main concern. In recent months, there has been a drop in net interest income due to this increased competition.
    • In insurance, there have been significant fluctuations in revenues and profits, and there is potential for losses in the future due to economic downturns.
    • The company has a relatively high exposure to Peruvian Sovereign debt which could negatively affect the company if there is a default from the Peruvian government.
  • Management’s Response to the Concerns:
    • Management acknowledges the competitive pressures in its different business lines, which has affected its margins and growth.
    • They are focused on improving efficiency, building a customer-centric approach, increasing their digital capabilities, and growing their wealth management business, which is less capital-intensive.
    • Management also plans to optimize the capital structure while focusing on long term value creation, which will likely improve ROE.

Moat Analysis

  • Intangible Assets (Brand): IFS has a strong brand in the Peruvian market. However, due to increased competition from new entrants and other factors, it can’t maintain pricing power to a large extent. The value of brand is relatively weak against global peers.
  • Switching Costs: While there are switching costs in banking, such as the inconvenience of changing banks, and the time it will take, those barriers are unlikely to give IFS a sustainable advantage.
  • Network Effect: The network effect is only slightly present in banking because the value proposition increases with more clients.
  • Cost Advantages: While the company has some operational efficiencies, those are not that special or difficult to replicate by peers and are not a durable source of advantage. It is harder to compete against cost leaders like low cost-fintech startups.
  • Size Advantage: The company is among the leading financial services group, with a large market share. In some cases size is helpful because of the density of the routes, branches, relationships, etc., but this is not sufficient in creating a long-term competitive advantage.

Moat Rating: Based on the analysis, IFS is assigned a moat rating of 3 out of 5. The company has some competitive strengths due to brand and local knowledge. However, the threats are very high, competition is intense, there is increasing disintermediation in the banking industry, and regulation is a key factor. These factors mean that the moat is difficult to build and the company faces constant competitive pressures.

Risks to the Moat and Business Resilience

  • Economic Instability in Peru: Due to the high reliance on Peru, the company is very susceptible to changes in the Peruvian economy. Any economic slowdown or increased credit defaults would be a serious blow to profitability.
  • Increased Competition: Both new entrants and local expansion will continue to increase the competition in the sector. New fintech companies are also trying to disintermediate the banking business.
  • Regulatory Changes: Financial services are highly regulated, and changing regulatory requirements or policies can affect the operations and profitability of the company. In particular, the Central Bank’s influence on interest rates, capital allocation and liquidity are the most important factors in the company’s ability to create long-term value. A recent study shows that having less regulated financial system produces high volatility and lower profitability.
  • Technology Disruption: New tech trends like fintech innovations and mobile payments could disrupt their conventional business models.
  • Geopolitical risk: The Peruvian government has shown a pattern of political instability. As a result, there could be significant changes to the rules and regulations in the country, that could affect the profits and growth of companies, including IFS.
  • Management Risk: If management does not take the correct steps to adopt to the changing times, and execute well, this will have a negative impact on the company’s profits and future.
  • Concentration of operations in Peru: IFS’s excessive reliance on Peru’s economic performance is another risk that could drastically impact operations if the Peruvian economy slows down or a credit crises occurs, where a large portion of IFS’s loans are.

Business Resilience: The ability of IFS to maintain operations or recover from temporary issues is rated as moderate. It may have more resilience due to its established brand and client base but is more vulnerable to the above risks, mainly industry/country-related.

Understandability

  • Simplicity of Business Model: While diversified, the core business of IFS is not too complex to understand, especially their traditional activities like banking and insurance. The payment business has some extra nuances but are still easy to grasp for an experienced investor.
  • Ease of Analyzing Financials: A few adjustments to the financial results are needed to fully understand the business. Most statements are reported in a clear and transparent way, making it easy to analyze. However, there are some complex issues regarding the impact of government regulation on the business.
  • Complexity of Operations: The operations are done mainly in Peru, but they also have complex intercompany relationships, and some businesses are not as simple as traditional lending or insurance. The wealth management business is the most difficult to understand.

Understandability Rating: The company’s business is not that complex, given the different segments, so IFS is assigned a rating of 4 out of 5 in terms of understandability.

Balance Sheet Health

  • Capital Structure: The company’s debt to equity ratio is conservative. The company is not relying heavily on debt.
  • Liquidity: The cash on hand is quite considerable and more than capable of serving the company’s liabilities. However, the bulk of the liabilities are very short-term.
  • Goodwill and Intangibles: These are still high and can be a source of overvaluation and reduced equity in the company.

Balance Sheet Health: IFS is given a balance sheet health rating of 4 out of 5. Debt is not very high, and the company has good liquidity. However, the composition of debt and intangibles make the balance sheet less healthy than those with more predictable liabilities and tangible assets.

Overall Remarks

IFS is a solid player in the Peruvian financial services sector with a decent presence, and has good long-term growth opportunities. Management acknowledges the difficulties facing the company, and are taking steps to ensure long-term value creation. However, IFS faces intense competition from local and international players, disruptive threats from fintech companies, and political and economic uncertainty from its main operating country, Peru. Therefore, an investor has to be cautious about these factors.