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Dividend stock RCECAP (9296) is a finance stock listed in Malaysia Bursa main market. Due to its track record to constantly deliver stable growth for many years, including year 2020 with the impact from COVID-19 pandemic, it started gaining attention in market. Share price of RCECAP has appreciated a lot in 2020. With its share price of around RM2.80 at time of writing, the dividend yield is expected to be around 4%.

(Last update: Based on quarterly financial report issued on 9th Feb 2021. Updates are made in red. For readers that would like to read superseded version, please free to contact by email)

Background of RCE

RCE Capital (9296) is financial service company listed in Malaysia Bursa Main Market. Main business of RCE is to provide personal financing to members of Yayasan Ihsan Rakyat (YIR) and Yayasa Dewan Perniagaan Melayu Perlis (YYP). Members of these two foundations are mainly government employee, and repayments of personal loan are done through salary deduction scheme.

Business of RCE has been growing for past 6 years, and RCE has been paying dividend twice a year with dividend payout of 20% to 40%.

Business model

Picture below taken from Maybank Investment Bank’s research report available here clearly illustrates business model of RCE.

Focus on niche market

Strategy of RCE is focusing on niche market providing personal financing to civil servants through salary deduction scheme. The closest competitors to RCE in this niche market would be MBSB and Bank Rakyat.

Looking at official website of RCE, it mentions that business activities include consumer financing, payroll collection and commercial financing. 

• Consumer financing, which basically is providing personal loans to civil servants,
• Payroll collection is getting repayment from civil servants through salary deduction scheme
• Commercial financing, but contribution is negligible. As a rough idea, at Q1 of 2020, loan receivable from consumer financing is about RM1.6 billion whereas receivable from commercial financing is only about RM3 million.

To summary, it is important to remember that RCE is a niche market player. How well RCE is doing in the business of providing personal financing to civil servants decide its complete financial performance.

Source of capital

For conventional banks, they get deposit from consumer & business at one hand, and lend it out on the other hand, earning the interest difference between the two.

In comparison, RCE is doing similar things – borrow money at one hand and lend it to civil servants on the other hand. But unlike banks, RCE does not offer bank accounts to get deposit as its working capital. So how RCE obtain its capital?

Understanding how RCE funds their capital is important, because this decides their cost to run the business.

Below are debt securities type that RCE use to fund capital.

• Term loan
• Revolving credit
• Sukuk (Islamic bond)

In earlier years, RCE used to borrow capital from term loan, revolving credit and medium-term note (MTN). Beginning from financial year 2017, RCE has established its own Sukuk (Islamic bond) program. Nowadays, Sukuk has become its main source to borrow capital.

Interest rate profile

It is important to read “interest rate and liquidity risk table” in their annual reports (note that this table is not available in quarterly financial reports). Below is the table taken from the latest annual report for financial year 2020 at the time of writing.

So what are important information from this table?

1. Average interest of loan provided to customers. From this table, can see on average RCE charged 13.25% loan interest (wah!)
2. Main source of funding and cost of interest rate. As mentioned earlier, Sukuk is main source of borrowing now (RM 1 billion), compared to term loans (RM0.2 billion). In addition, Sukuk bears lower interest of 5.39% compared to term loan at (5.73%). So I can say RCE has done a good job switching to Sukuk to lower funding cost
3. How much borrowing bears floating interest rate. This tells us how much borrowing will be impacted by change in overnight policy rate (OPR). In addition, RCE has also provided separate disclosure in the report, saying lower/higher of interest rate by 0.5% will increase/decrease profit by RM2.5 million.
4. Trend of interest rate compared to previous year. Comparing financial year 2020 and 2019, on average RCE charged higher loan interest rate to customers (13.25% compared to 13.15%) while borrowing of interest rate is lower. Bigger the interest rate difference = Bigger profit margin !
5. Note that personal loans that RCE provides is fixed rate.

Why low interest environment is good for RCE?

• RCE charged fixed interest to customers. On the other hand, certain portion of their borrowings are floating interest. So decrease in OPR rate will widen the interest rate difference and boost its profit margin,

• Whenever new Sukuk is issued, it will be priced based on the current interest rate. Low OPR rate will also offer RCE opportunities to optimize their borrowing structure to improve margin.

Impairment

Business of RCE is to provide personal loan to civil servant. Personal loan is a type of unsecured loan so impairment rate would be higher than other loan type, such as mortgage loan. Below are impairment rates of RCE of the past 5 years

	Impairment rate
2016	7.63%
2017	7.28%
2018	7.22%	.
2019	7.54%	Start implementation of  MFRS 9
2020	7.15%

Except for financial year 2019 which impairment rate is higher after implementation of new accounting standard MFRS 9, impairment rate is actually gradually improved over the years.

Read more here for what is MFRS 9 and how it impacts financial reports.

Since loan repayment from customers is through salary deduction scheme, in what scenario loan impairment occurs? According to resource here, the most common reasons cited by management are civil servants’ early retirement or prolonged absences from work.

Financial highlights (Quarterly Report of 2020 Q4 / FY2021 Q3)

• For period of nine months until December 2020 in current financial year, revenue improved by 4.2% and earning per share improved by 7.5%.

• It is also a better performance compared to previous quarter, revenue went up by 7.5% and earning per share increased by 4.2%.

• Better performance than previous quarter was attributed to lower staff cost, higher early settlement profit, normalization of impairment and lower borrowing cost resulted from low interest environment.

• Please note that RCE issued Employee Share Options (ESS) to staff every year. As a result, shareholding percentage of investors gets small degree of dilution every year (up to 3%). Hence when evaluating performance of RCE, please judge by earning per share (EPS) instead of net profit. Personally, I’m not too concerned about dilution from ESS. If it motivates employees to work harder and the end result is EPS still growing every year, it is not a problem.

• As mentioned above, loan interest rate charged by RCE to customers is not impacted by drop in OPR rate. On the other hand, lower OPR rate means lower borrowing for RCE. So reduction in OPR is beneficial to RCE.

• RCE has two Sukuk programs. First Sukuk program with value of RM800 million has been fully utilized. Value of second sukuk program is RM2 billion and only RM500 million has been issued up to financial year 2020. In current financial year, a further RM220 million of sukuk was issued. Remaining balance of approximately RM1.3 billion Sukuk provides ample liquidity to RCE to fund their working capital and optimize their borrowing cost.

• Strategy of RCE is to use short term financing, such as revolving credit, to built loan receivables. Once the loan receivables reached a level, they will be used as securities for issuance of new Sukuk. In Q3 and Q4 of 2020, RCE has repaid a large sum of revolving credit, and converted them into Sukuk and term loan. With the low interest environment now, this must lower their borrowing cost and boost net profit.

• For dividend payout, RCE has a guideline to pay 20% to 40% of net profit as dividend. Dividend payout has been increasing over years, it stood at 35.1% for financial year 2020 ending March 2020. The reason for increasing dividend payout was disclosed in annual report FY2019, “Taking into consideration our stable earnings and availability of sustainable funding programme for next few years, capital previously allocated for business growth could now be redistributed to shareholders”.

• RCE generates more cash flow from operation compared to previous financial year. That is not necessary a good thing for business model of RCE. To maximize profitability, I would want Company to take the cash generated to further lend to other customers to generate profit. In this case, it would result in positive operating cash flow before change in working capital, but negative net operating cash flow. On the other hand, I believe company also has their own consideration, lending money to bad customers is also not good.

• Positive net operating cash flow could be a sign that loan growth is slowing, which is true for RCE. In the latest quarter ending Dec 2020, the gross loan amount is about the same as the end of previous financial year. I reckon COVID still has some impact on the loan growth, because people tend to be more cautious on spending.

• Impairment allowance calculated by RCE includes a factor called forecasted GDP (FGDP). Since GCP of Malaysia is expected to contract, calculated impairment loss will be higher. Good thing is, for current financial year of 2021, this only affected result of FY2021 Q1 so far. Impairment loss of the latest quarter has normalized from FY2021 Q2. Until FY2021 Q3, on accumulative basis, it can be seen that impairment loss for period of 3 quarters is actually about the same as last year. For me, this is an indication that COVID-19 pandemic does not deteriorate loan quality of RCE, since their target market – civil servants are largely unaffected by pandemic.

End

• In my opinion, RCE has already survived through the economic crisis brought by COVID-19 pandemic. This is because of unique shelters possessed by RCE includes customer base made by civil servants, repayment is done through salary deduction, beneficiary of low interest rate environment and ample liquidity from Sukuk program. Also RCE is not bank and hence do not need to comply with loan payment moratorium.

(Read more here about how loan moratorium affects banks)

• In 2020, loan growth of RCE is actually flat compared to previous year. The better financial results in 2020 is because of (1) increase in early settlement income arising form higher refinancing activities by customers (2) lower cost structure due to lower interest rate environment. In 2021, many economists foresee banking sector to return to growth. I believe RCE can also start to grow their loan size in 2021 while still reaping the benefit of low interest environment.

• At time of writing, RCE is trading at return of equity (ROE) of 15% and dividend yield of 4%.

• In 2020, appreciation in share price of RCE is much more than their profit growth. So in 2021, there could still be room in appreciation in share price if RCE continues to deliver better result, however I expect the extent of appreciation should be much more subdued. On the other hand, it is possible for RCE to pay more dividend in 2021, and this is a very important point for investors employing dividend growth strategy.

In case you want to know more about dividend investing, feel free to check out my article about ultimate guideline for dividend investing here.

Disclaimer: This article is purely my notes from studying this company. This is not a BUY or SELL call. I am not a registered investment advisor nor an investment guru, please be reminded to do your own homework and invest at your own risk.