EU banks outperformed the broad market significantly in July after a notable underperformance in June. Moreover, it was the 18th time of outperformance over the last 24 months. Also, the EU banking index (SX7P) ended the month in the green, for the 8th time over the last 9 months.
EXECUTIVE SUMMARY
EU banks outperformed the broad market significantly in July after a notable underperformance in June. Moreover, it was the 18th time of outperformance over the last 24 months. Also, the EU banking index (SX7P) ended the month in the green, for the 8th time over the last 9 months. The index increased by 5.6% MoM in July vs +1.3% MoM of STOXX 600 index. Absolute July 2024 performance was +0.8 std from the mean monthly performance, and it was in the top 16% of absolute monthly performance in the index history. Relative July 2024 performance was +4.2% MoM. It is +1.1 std from the mean monthly performance, and it is in the top 11% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 36.9% over the last 24 months, but just by 7.7% since February 2022 because of significant decline in March 2023. Despite stronger dynamics in the last two years, SX7P index underperformed the broad market significantly in each of 2018-2020 years. Nonetheless, as of the end of July, it has already been 11.7% higher than it was at the end of 2017, but still underperforming STOXX 600 index by 16.1% over this period. Despite still relatively weak economic projections, the start of ECB’s rate cut cycle and roughly flat EPS estimates ytd, more than 90% banks from our sample ended the month in the green, driven by the stronger 2Q24 earnings season. So, even declines of the worst performers of the July were insignificant. In turn, the best performers – NWG LN, BPE IM and BARC LN – increased by 18.1% MoM, 14.4% MoM and 11.9% MoM in July, respectively. Nonetheless, variability of monthly price changes decreased again, for the 4th consecutive month, even despite the start of the earnings season. Thus, a difference of monthly price changes between the best and the worst performers was 22.3% in July vs 24.9% in June, 29.6% in 2Q24 and 34.6% in 4Q23. But correlation among EU banks between price changes ytd and EPS FY24E changes ytd decreased slightly again in July, for the third consecutive month, remaining quite low, especially vs US Banks.
Despite noticeable outperformance of EU banks in recent years, they continue trading with a significant discount both to historical averages and to STOXX 600 index as EPS estimates growth also remains quite high. Nonetheless, median P/E 24E of our group of banks decreased again, falling from 7.0x (as of June 28, 2024) to 6.7x (as of August 8). In turn, median P/E 25E went down from 7.1x (as of June 28, 2024) to 6.6x (as of August 8). But both ratios are not very far from levels of the end of 2022. Nonetheless, banks are still trading at -1.61/-1.6 std on P/E CY and at -1.21/-1.2 std on P/E NY (on the basis of samples from 2006 and 2010 years) relative to historical averages. As for valuations 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 -1.35 std for P/E NY. Moreover, the discount to US banks also remains much wider than on average, staying at -1.6/-1.2 std for P/E CY/NY as of August 8. Median P/B of our group of banks also decreased slightly during the last month, decreasing from 0.84x as of June 28, 2024 to 0.8x as of August 8. 2H23-1Q24 ROE were the highest figures since the pre-GFC era, and it would remain quite high vs average ROE of post-GFC in the nearest years, albeit a few percent below current levels. As for individual names, multipliers are still quite different, but dispersion across banks has decreased recently. However, RBI’s P/E estimates for the nearest years remains just around 3x at the moment while UBS’s ratios vary from 18.2x for 2024 year to 7.9x for 2026 year.
Growth of the EU economy continues accelerating even despite slowing momentum in the global economy. Against all recent fears, the momentum in the EU should even improve, at least near-term, due to the start of ECB’s easing cycle. Moreover, we expect that the start of the easing cycle by the Fed will give an additional boost to the ECB to cut rates faster even in case of resilience of inflation. By the way, the latter continues moving in the right direction. Nonetheless, the wording about inflation in the July statement remained cautious. Moreover, according to ECB’s projections revealed in June, inflation forecasts for 2024 and 2025 years were revised up by 20 bps vs March projections. Nonetheless, rate expectations decreased noticeably in recent months. Thus, according to the current market expectations, we will see around 4 rate cuts with total decline of around 100 bps in 2024 (approximately three more till the end of the year) vs expectations at the beginning of 2024 of almost 7 rate cuts with total cut of around 170 bps but around 75 bps as of the end of 2Q24. On the other hand, recession probability increased slightly in July, growing to 30% from 20% in June, which was the lowest figure over more than 2.5 years. But it was 65% at the beginning of the year. Moreover, EU macro data published in July were slightly worse than expected again, confirming that the recovery is still pretty fragile. Unsurprisingly, ECB still believes that risks to economic growth are tilted to the downside. Definitely, it is too early to say that the EU economy is completely out of the woods given a notable growth political uncertainty but the baseline scenario is still intact – gradual accelerating of the recovery, driven by consumption.
2Q24 earnings confirmed that fundamentals of EU banks remain strong. Nonetheless, despite better both 2Q24 earnings and improved FY24 outlooks, EU banks decreased notably since the start of the earnings season, driven by growth of global macro risks, still high political uncertainty as well as possible faster-than-expected interest rate cuts. Thus, more than 85% of the banks from our sample that had already released results exceeded revenue expectations with a median surprise of 2.1%. More than 90% of banks reported higher EPS figures but with a median surprise of +7.7%. Higher-than-expected net income was mainly driven by better fee income and still strong asset quality while NII figures were roughly in-line with expectations due to higher-for-longer interest rates environment, at least until so far. Nonetheless, the earnings momentum continued deteriorating, despite steady acceleration of the EU economy. Thus, 2Q24 was the 14th consecutive quarter of positive revenue growth on a yoy basis, but a median growth of our sample of banks was just +2.6% vs around 20% yoy in 2Q23. In turn, NII even decreased by 2.2% in 2Q24 while fees went up by 8.4%. So, operating income was also negative, for the first time over more than three years. Given ongoing growth of OpEx, operating leverage also turned negative in 2Q24, for the first time over the last 14 quarters. In turn, loan growth stopped decelerating recently, and banks expected gradual accelerating of loan growth in 2H24, driven by faster recovery of the EU economy. So, fundamentals of EU banks remain quite strong with median ROE above 13% in 1H24, the highest level since the pre-GFC era. On the other hand, we don’t expect any significant growth of EU banks revenue in the nearest two years, which also implies limited profit growth. Moreover, risks of EPS decline have increased recently but still look constrained, from our point of view. In other words, earnings visibility of EU banks is still uncertain, and it may even deteriorate fast, especially in case of recession in the United States. But given recent sell-off, it is partially priced in. Moreover, under the current baseline scenario, it is implied that EPS growth will remain positive albeit much slower than in 2023. But the latter as well as high capital levels of EU banks also imply sustainability of current quite high capital returns, providing solid downside protection for the sector until significant deterioration of economic conditions. Despite attractive risk-reward, we still remain neutral on EU banks, expecting better entry point.
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