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  • Writer's pictureArbat Capital

EU Banking Sector Report - June 2023

EU banks outperformed the broad market again in May 2023, for the 9th time over the last 10 months. Nonetheless, SX7P index ended the month in the red for the second time over the last 3 months.


EXECUTIVE SUMMARY


EU banks outperformed the broad market again in May 2023, for the 9th time over the last 10 months. Nonetheless, SX7P index ended the month in the red for the second time over the last 3 months. The index decreased by 2.8% MoM in May vs -3.2% MoM of STOXX 600 index. Absolute May 2023 performance was -0.5 std from the mean monthly performance, and it was in the bottom 26% of absolute monthly performance in the index history. Relative May 2023 performance was +0.4% MoM. It is +0.15 std from the mean monthly performance, and it is in the top 40% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 10.8% over the last 10 months, but just by 4% ytd because of significant decline in March. However, despite stronger dynamics in the last two years, SX7P index underperformed the broad market significantly in each of 2018-2020 years. So, it is still 22% lower than it was at the end of 2017, underperforming STOXX 600 index by 32% over this period. Despite strong 1Q23 results and ongoing growth of EPS estimates, EU banks decreased noticeably in May 2023, and just 4 out of 36 banks from our sample managed to end the month in the green.

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 decreased from 7.09x (as of April 28, 2023) to 6.52x (as of June 2, 2023). In turn, median P/E 24E was roughly flat during the same period of time, remaining at 6.17x (as of June 2). Nonetheless, banks are still trading at -2.0/-2.2 std on P/E CY and at -1.6/-1.7 std on P/E NY (on the basis of samples from 2006 and 2010 years to the current moment) relative to historical averages. As for relative to STOXX 600 Index, banks are currently trading at -1.9 std from the sample mean (2010-current moment) for both P/E CY and P/E NY. Moreover, a discount to US banks also remains much wider than its historical average, -2.2/-1.7 std for P/E CY/NY as of June 2, 2023. Median P/B of our group of banks decreased from 0.73x (as of April 28, 2023) to 0.62x (as of June 2, 2023), roughly in line with its historical average despite significant growth of ROE in the recent quarters. 1Q23 ROE was the highest one since the GFC, and it will remain roughly flat in the nearest years. Multipliers are still quite different across our banks, but dispersion across our sample has decreased ytd. Thus, RBI’s P/E estimates for the nearest years are around 3x while UBS’s figures are 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 one as it is at the moment, from our point of view.

EU economy continues going up, albeit at a relatively low speed. It managed to avoid recession despite the recent energy crisis, skyrocketing rates growth and still elevated inflation. And although it is too early to say that the EU economy is completely out of the woods, it is definitely in a better shape than it was expected a few quarters ago. Thus, the EU labor market remains quite strong, with the unemployment rate having fallen to a new historical low of 6.5% in April. On the other hand, consumer sentiment and retail sales were relatively weak in the last months even despite some decline of energy prices and lower inflation. However, recent PMI figures point to growth continuation, even despite quite weak manufacturing component. So, GDP growth estimates increased noticeably in the recent months.

European banks reported markedly better results again in 1Q23 with positive surprises on both revenue and net income. Earnings momentum still remains strong, and operating profit growth continues accelerating. Nonetheless, despite quite strong fundamentals so far, we expect that earnings momentum will start deteriorating in the near future. At least, EU banks reported that their access to retail and wholesale funding had deteriorated in 1Q23, while deposits growth decelerated significantly in recent months. And we believe that deposit outflows will continue. Thus, total EU deposits increased just by 1.6% yoy in April 2023 vs +5.2% a year ago. So, loans growth has decelerated noticeably either. In such conditions, deposit beta will inevitably go up. Taking into account that the hiking cycle is near the end and lower/roughly flat rate expectations ytd, we expect that NII will reach its top in 2H23. So, we could see NII estimates downgrades in the near future, as it is already happening with NII estimates of US peers. At least, it is expected currently that NII will remain roughly flat yoy in 2024. So, NII tailwind could turn to headwind as early as next year, accompanied by ongoing costs growth because of elevated inflation as well as higher provisions caused by weak economic growth. Such a scenario does not imply any significant growth of banking quotes, especially taking into account outperformance of EU banks both yoy and ytd. On the other hand, we don’t expect substantial decline of EU banks either, given quite low valuations and very high dividend yields. So, we remain neutral on EU banks at the current moment.


AC - EU Banking Sector Report - Jun-2023
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