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  • Writer's pictureArbat Capital

EU Banking Sector Report - August 2023

EU banks outperformed the broad market again in July 2023, for the 4th consecutive month and for the 11th time over the last year. Moreover, SX7P index ended the month deeply in the green for the second consecutive month after decline in May.


EXECUTIVE SUMMARY


EU banks outperformed the broad market again in July 2023, for the 4th consecutive month and for the 11th time over the last year. Moreover, SX7P index ended the month deeply in the green for the second consecutive month after decline in May. The index increased by 5.4% MoM in July vs +2.0% MoM of STOXX 600 index. Absolute July 2023 performance was +0.7 std from the mean monthly performance, and it was in the top 18% of absolute monthly performance in the index history. Relative June 2023 performance was +3.3% MoM. It is +0.9 std from the mean monthly performance, and it is in the top 14% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 20.2% over the last 12 months, but just by 5.3% ytd because of their significant drop in March. However, despite stronger dynamics during last two years, SX7P index underperformed the broad market materially in each of 2018-2020 years. So, it is still 10.9% lower than it was at the end of 2017, underperforming STOXX 600 index by 26.4% over this period. Despite quite weak economic recovery during last three quarters, the more hawkish ECB and higher rate expectations remain the key positive drivers for EU banks. Only 3 out of 35 banks from our sample ended the month in the red in July 2023. Volatility of monthly price changes wasn’t high for EU banks ytd. Thus, average difference of monthly price change between the best and the worst performers among our banks sample was 24.7% for the first 7 months of 2023 vs an average for 2022 year of 30.7%. Similar to US peers, there was relatively high correlation among EU banks between price change ytd and EPS FY24E change ytd. It even increased from 66% in June to approximately 71% in July.

Despite recent outperformance of EU financial institutions, EU banks continue trading with a significant discount both to historical averages and to STOXX 600 Index as EPS estimates growth remains quite high. Thus, median P/E 23E of our group of banks increased from 6.55x (as of June 30, 2023) to 6.74x (as of July 28, 2023). In turn, median P/E 24E increased from 6.35x (as of June 30) to 6.51x (as of July 28). Both ratios remain noticeably lower vs the end of 2022. Nonetheless, banks are still trading at -1.9/-2.0 std on P/E CY and at -1.4/-1.4 std on P/E NY (on the basis of samples from 2006 and 2010 years to the current moment) relative to historical averages (as of July 28, 2023). As for relative to STOXX 600 Index, banks are currently trading at -1.8 std from the sample mean (2010-current moment) for P/E CY and -1.6 std for P/E NY. Moreover, a discount to US banks also remains much wider than the average, -2.0/-1.4 std for P/E CY/NY as of July 28, 2023. Median P/B of our group of banks increased from 0.64x (as of June 30, 2023) to 0.68x (as of July 28), roughly in line with historical average despite significant growth of ROE in the recent quarters. 2Q23 ROE was the highest one since pre-GFC era, and it will remain roughly flat in coming years. Multipliers are still quite different across our banks, but dispersion across our sample has decreased slightly ytd. Thus, RBI’s P/E estimates for the nearest years are around 3x while UBS’s average figure is around 9x. Given high RBI's exposure to Russia and the fact that a Russian part of RBI’s profit is a ‘paper’ profit, a certain discount looks justified, but not as high as it is at the moment, from our point of view.

According to the last 1Q23 GDP growth revision, the European economy still managed to avoid a recession during the last winter, and it even returned to the growth in 2Q23. Thus, EU GDP increased by 0.3% qoq, or +0.6% yoy, in 2Q23 vs the consensus of +0.2% qoq, or +1.5% yoy, and 1Q23 growth rate of 1.1% yoy, but flat qoq (up from the previous estimate of -0.1% qoq). On a yoy basis, EU GDP growth was positive for the 9th consecutive quarter after 5 quarters of negative dynamics in a row. So, taking into account initial forecasts and realized risks, dynamics of the European economy was noticeably better than it had been expected. But it is too early to say that it is completely out of the woods given substantial growth of key rates and still quite high level of uncertainty. At least, we have already seen substantial deceleration of the loan growth and quite weak credit impulse in recent months because of very fast monetary tightening. Moreover, Europe’s largest economy, the German one, is still in recession. According to the recent ECB’s introductory statement, the near-term economic outlook for the euro area has deteriorated while the economy is expected to remain weak in the short run. Thus, EU macro data published in July weren’t strong again with retail sales, industrial production and PMI indices miss but better GDP figures. So, the downside scenario still implies that the EU economy could continue shrinking, but we don’t expect that GDP growth will be negative on a yoy basis in 2023.

European banks reported markedly better results again in 2Q23 with positive surprises on both revenue and net income. Thus, 19 out of 23 banks from our group of banks for which consensus estimates were available and which revealed results till the end of July reported better EPS figures and 18 out of 23 higher net income figures. In turn, revenue exceeded estimates for 20 out of 23 banks with available estimates in 2Q23. Median revenue surprise was +2.4%, markedly better than median quarterly surprise over the last 10 years of +1.2%. So, earnings momentum still remains quite strong, and it even continues improving so far, but the speed of improving have decelerated recently. Thus, median growth of operating profit of our group of banks (which has already reported) was +47% yoy in 2Q23 vs +46% yoy in 1Q23 and -0.5% yoy in 2Q22. Median growth of revenue was +20.8% yoy in 2Q23 vs 22.4% yoy in 1Q23, the 10th quarter of positive yoy growth in a row. EU banks reported that their access to retail and wholesale funding had deteriorated in 1H23 while both deposit and loan growth decelerated significantly in recent months. Thus, total EU deposits (corporate + retail) increased just by 1.1% yoy in June 2023 vs +4.4% a year ago, while it was already negative in Spain and Italy. In turn, corporate loans increased by 2.2% yoy in June 2023, while consumer loans went up by 1.2% yoy vs 6.1% yoy and 4.8% yoy a year ago, respectively. Taking into account that the hiking cycle is near the end, even despite the more hawkish ECB until recently, we expect that NII growth will peak in 2H23. So, we could even see NII estimates downgrades in the near future, as it is already happening with NII estimates of US/UK peers. At least, it is expected currently that NII will remain roughly flat yoy in 2024. In other words, NII tailwind could turn to a headwind as early as the next year, accompanied by ongoing costs growth because of still elevated inflation as well as higher provisions caused by weaker economic growth. Such a scenario does not imply any significant growth of banking quotes, especially taking into account recent outperformance of EU banks both yoy and ytd. On the other hand, we don’t expect substantial decline of EU banks either, given still positive GDP growth, quite low valuations and very high dividend yields. So, we remain neutral on EU banks at the current moment.


AC - EU Banking Sector Report - Aug-2023
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