The cost of setting up a bank will weigh on Discovery's earnings, but as a long-term play it is expected to pay off if it draws customers from outside its fold.
Discovery flagged a lower half-year profit on Friday as the cost of setting up new businesses affected the group's earnings.
The insurance group known best for its medical fund is opening a bank and a retirement business and is pushing deeper into foreign markets, as part of a multi-year strategy to deploy its steady cashflow to establish future streams of income.
These investments, mostly the new bank, reduced earnings on the income statement by about 21% for the six months to December, the company said.
As a result it will report a 16% drop in headline earnings per share to about 366c.
Shares in Discovery fell nearly 6% after the announcement, despite reassurances by the company that the spending on new businesses is as budgeted and is fully provided for in its capital plan.
"On the multiple they trade, the expectation is that they will grow profit every time," said Vestact portfolio manager Michael Treherne.
Discovery has been reporting growing profits for at least the past decade and the trading update follows recent earnings warnings by other market favourites, such as Shoprite, which also sparked a sell-off on the day. But Treherne still sees it as a positive indication that Discovery is able to finance its new business development from its own resources, without having to tap shareholders for more funds.
Discovery Bank is expected to go live to the public next month after the Reserve Bank delayed last year's initial launch date due to concerns it had about the stability of the sector as FirstRand would also have held a stake in the new institution.
Discovery has since agreed to buy out this stake over the next few years and the bank started in beta mode — a launch to a small pool of customers for testing — late last year.
The bank will initially position itself to open accounts for its existing credit card clients and will also try to lure other individuals away from the big four banks and Investec.
Denker Capital portfolio manager Jan Meintjes said Discovery has a very good record in establishing new businesses that grow into their existing client base.
"This usually means a few years of losses in the new business, but then very rapid growth. I don't think the bank will be any different . the impact will be big this year due to the scale they have to build for the bank, but the impact will lessen substantially over the next three years," said Meintjes.
Discovery CEO Adrian Gore has said before that the bank is unlikely to break even in the first five years.
And it will enter a highly competitive market alongside new entrants Zero Bank and African Rainbow Capital's Tyme.
"Everyone is up for grabs," said Treherne, but added that Discovery will likely make its strongest play for the high-income end of the market.
Capitec has been pinching thrifty clients from other institutions for years, raking in more than 200,000 new accounts in January alone.
Tyme also said it had signed up 50,000 clients since launching its first phase in some Pick n Pay stores late last year.
To get really good returns in the banking business, Discovery will have to attract clients from outside its current pool, said Meintjes.
"Given the competitive landscape in banking today, with new innovators and capital-rich giants taking each other on, it won't be easy," he said.
In the meantime, Discovery has an established financial services business it can count on as it builds scale for its bank.
Most of the company's operations will show strong growth when it reports results on Thursday.
But one of its long-established units also had a negative impact on profit.
"Discovery Life experienced a spike in high-value mortality claims, which will reduce its operating profit by 18% and is expected to negatively impact [group] earnings by approximately 8%," the company said.
The company has rejigged its reinsurance structures to steel it against this sort of volatility in future.
"Discovery's established businesses are well positioned for growth, with Discovery Life expected to revert to target growth levels," it said...