EU banks outperformed the broad market again in March, for the second consecutive month. Moreover, it was the 15th time of outperformance over the last 20 months. Also, SX7P index ended the month in the green, for the 14th time over the last 18 months.
EXECUTIVE SUMMARY
EU banks outperformed the broad market again in March, for the second consecutive month. Moreover, it was the 15th time of outperformance over the last 20 months. Also, SX7P index ended the month in the green, for the 14th time over the last 18 months. The index soared by 9.1% MoM in March vs +3.7% MoM of STOXX 600 index. Absolute March 2024 performance was +1.3 std from the mean monthly performance, and it was in the top 6% of absolute monthly performance in the index history. Relative March 2024 performance was +5.2% MoM. It is +1.4 std from the mean monthly performance, and it is in the top 7% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 28.1% over the last 20 months, but by just 12.2% since the end of 2022 because of significant decline in March 2023. However, despite stronger dynamics in the last two years, SX7P index underperformed the broad market significantly in each of 2018-2020 years. So, now it is just 3.4% higher than it was at the end of 2017, underperforming STOXX 600 index by 21.5% over this period. Despite still weak economic projections, mixed 4Q23 earnings season and roughly flat EPS estimates ytd, more than 80% of our sample of banks ended the month in the green, mainly driven by encouraging 2024 outlooks and forthcoming start of the monetary easing. However, variability of monthly price changes increased noticeably again in March, mainly driven by VMUK’s skyrocketing growth. Thus, a difference of monthly price changes between the best and the worst performers was 50.7% in March, translating to 34.7% in 1Q24, vs 34.6% in 4Q23. But correlation among EU banks between price changes ytd and EPS FY24E changes ytd increased notably in March after its significant decline in the first two months of the year, mainly driven by investors’ reaction to 4Q23 earnings. Due to significant growth in 4Q23, UBS remains the biggest outlier as its EPS estimates decreased significantly. Thus, the bank increased by 44% yoy as of the end of March while its FY24 EPS estimate was revised down by 60% yoy.
Despite noticeable outperformance of EU financial institutions in 2023, EU banks continue trading with a significant discount both to historical averages and to STOXX 600 index as EPS estimates growth also remains quite high. Thus, median P/E 24E of our group of banks increased from 6.6x (as of March 6, 2024) to 7.1x (as of March 28). In turn, median P/E 25E went up from 6.6x (as of March 6, 2024) to 6.9x (as of March 29). Both ratios remained noticeably lower vs the end of 2022. So, banks are still trading at -1.5/-1.5 std on P/E CY and at -1.1/-1.0 std on P/E NY (on the basis of samples from 2006 and 2010 years) relative to historical averages. As for relative to STOXX 600 index, banks are currently trading at -1.5 std from the sample mean (2010-current moment) for P/E CY and -1.1 std for P/E NY. Moreover, the discount to US banks also remains much wider than on average, -1.5/-1.0 std for P/E CY/NY as of March 28. Median P/B of our group of banks also increased during the last month, growing from 0.78x as of March 6, 2024 to 0.84x as of March 28. 4Q23 ROE was the highest one since the pre-GFC era, and it would remain quite high vs average ROE of the post-GFC period in the nearest years, albeit a few percent below the 4Q23 figure. As for individual names, multipliers are still quite different, but dispersion across banks has decreased recently. Thus, RBI’s P/E estimates for the nearest years are around 3-4x while SHBA’s average ratio is around 9x and industry’s average ratio is 7.1x. In turn, an average discount of P/E of British banks to P/E of other EU banks is still around 30%, much higher than historical averages.
The EU economy still remains weak, going up slower than December expectations. So, macro data released in March wasn’t strong again but the growth momentum continues gradually improving albeit gently. The EU economy continues stagnating as a result of still tight financial conditions, despite a notable decline of inflation in recent quarters. Nonetheless, it is expected that the EU economy will return to growth as early as in 1Q24, but the growth will be quite weak in 1H24, only a few dozen of basis points. Moreover, risk of falling into recession still remains high albeit decreasing in recent months. So, EU macro data published in March wasn’t strong again with slightly worse than expected retail sales, much weaker industrial production and manufacturing PMI but notably higher services PMI and better than expected PPI. In its turn, the labour market continues gradually cooling, accompanied by a slowing wage growth. The latter is a necessary condition for inflation to continue moving in the right direction. On the other hand, it also means that the ECB will not rush to lower rates as the cost of premature monetary easing looks quite high. So, interest rate expectations increased notably ytd but they were roughly flat in March. Now, it is expected that the easing cycle will start only in June with total cut of less than 100 bps in 2024 (as of the end of March) vs expectations of more than 150 bps total cut just 2 months ago. Nonetheless, the lagged effects of too high interest rates maintained longer than necessary may well surprise us with a minus sign already in the nearest future. At least, EU manufacturing activity still remained quite weak and deteriorating in March while the emerging turnaround of the EU economy may quickly be replaced by a new fall. So, risks are still tilted to the downside.
1Q24 fundamentals will remain strong, but we expect further deterioration of the earnings momentum in the near quarters even in case of faster economic recovery in the EU. The key forthcoming event – the 1Q24 earnings season – will begin at the end of the second decade of April and will mostly be completed by the end of the first decade of May. Despite ongoing outperformance of EU banks in 1Q24, the 4Q23 earnings season wasn’t strong for EU banks. Indeed, although profitability ratios still remain at multi-decade highs, there is no upside potential for the indicators, given challenging revenue environment ahead, driven by weak NIM/NII dynamics as a result of inevitable decline of key rates and restrained loan growth in the near future. Thus, less than half of the banks from our sample exceeded revenue expectations in 4Q23. So, growth of both revenue and operating income decelerated significantly in 4Q23. In turn, it was the 12th quarter of positive yoy revenue growth in a row, but the days of a double-digit growth are already behind us. However, it is still expected that a revenue growth will remain positive in 2024 despite upcoming start of ECB’s rate cut cycle. And it does not matter at all whether it happens in April or in June, which is currently a rather heated discussion. The important thing is that this is almost a fait accompli (given recent inflation data) as well as expectations of relatively fast rate cutting. Hence, asset yields have already started to decline while cost of funding still continues being resilient. In turn, credit impulse still remained quite weak albeit the second derivative of both deposit and loan growth improved slightly in recent months. Unsurprisingly, it is already expected that NII will be roughly flat on a yoy basis in both 2024 and 2025 years. Also, credit quality is gradually deteriorating while OpEx growth continues. Hence, it means relatively high probability of downgrades of EPS estimates in the near term. At least, estimates were roughly flat ytd. Such a scenario does not imply any significant re-rating of EU banks even despite still relatively low valuations. On the other hand, we don’t expect substantial decline of EU banks either, given positive and improving GDP growth, still attractive valuations and very high capital returns. So, we remain neutral on EU banks since the benefits are largely offset by the risks, which, however, continue to grow.