EU banks outperformed the broad market again in May, for the 4th consecutive month. Moreover, it was the 17th time of outperformance over the last 22 months. Also, EU banks (SX7P index) ended the month in the green for the 16th time over the last 20 months.
EXECUTIVE SUMMARY
EU banks outperformed the broad market again in May, for the 4th consecutive month. Moreover, it was the 17th time of outperformance over the last 22 months. Also, EU banks (SX7P index) ended the month in the green for the 16th time over the last 20 months. The index increased by 4.0% MoM in May vs +2.6% MoM of STOXX 600 index. Absolute May 2024 performance was +0.5 std from the mean monthly performance, and it was in the top 27% of absolute monthly performance in the index history. Relative May 2024 performance was +1.3% MoM. It is +0.4 std from the mean monthly performance, and it is in the top 30% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 35.6% over the last 22 months, but just by 6.6% since February 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. Nonetheless, as of the end of May, it has already been 10.6% higher than it was at the end of 2017, but still underperforming STOXX 600 index by 16.9% over this period. Despite still relatively weak economic projections, an upcoming start of the rate cut cycle and roughly flat EPS estimates ytd, more than 80% of our sample of banks ended the month in the green, mainly driven by better 1Q24 earnings and encouraging 2024 outlooks. Hence, variability of monthly price changes decreased again in May, for the second consecutive month, even despite continuation of the earnings season. Thus, the difference of monthly price changes between the best and the worst performers was 27.9% in May vs 35.9% in April or 34.7% in 1Q24 and 34.6% in 4Q23. An average difference of monthly price changes between the best and the worst performers among our banks sample was 27.8% in 2023 vs an average for 2022 year of 30.7%. However, correlation among EU banks between price changes ytd and EPS FY24E changes ytd decreased slightly in May, after its growth in April. UBS still remains the biggest outlier, especially after significant growth of its quotes in May, driven by better 1Q24 earnings.
Despite noticeable outperformance of EU banks in recent years, they continue trading with a significant discount both to historical averages and to the broad market (STOXX 600 index) as their EPS estimates growth also remains quite high. Thus, median P/E 24E of our group of banks increased from 7.4x (as of May 3, 2024) to 7.7x (as of May 31). In turn, median P/E 25E went up from 7.1x (as of May 3, 2024) to 7.3x (as of May 31). So, both ratios have already returned to levels of the end of 2022. Nonetheless, banks are still trading at -1.17/-1.15 std on P/E CY and at -0.82/-0.78 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, the banks are currently trading at -1.17 std from the sample mean (2010-current moment) for P/E CY and -1.03 std for P/E NY. Moreover, a discount to US banks also remains much wider than on average, staying at -1.15/-0.78 std for P/E CY/NY as of May 31. Median P/B of our group of banks also increased slightly during the last month, climbing up from 0.84x as of May 3, 2024 to 0.87x as of May 31. 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. Nonetheless, RBI’s P/E estimates for the nearest years are still just around 3x while UBS’s ratios are from 24.2x for 2024 year to 9.0x for 2026 year and industry’s average ratio for the nearest three years is 7.3x.
The EU economy continues recovering, and its momentum will even improve in the nearest future due to an upcoming start of the monetary easing cycle. Inflation continues moving in the right direction, so, according to the market expectations and ECB’s commentaries during the last meeting, the first rate cut in June looks almost as a done deal. Thus, core CPI increased by 2.9% yoy in April vs the consensus of 2.7% yoy, up 20 bps from the lowest figure over the last 28 months. In turn, PPI went down by 5.7% yoy in April, being negative on a yoy basis for 12th consecutive month. The key open question at the moment is how fast the monetary easing will be. Current projections imply that we could see three rate cuts already in 2024, comparing to expectations of almost 7 rate cuts with total cut of around 170 bps at the beginning of 2024. Nonetheless, despite still very tight financial conditions and much higher rate expectations ytd, the EU economy continued growing above expectations so far. Thus, EU GDP increased by 0.3% qoq, or +0.2% yoy, in 1Q24 vs the consensus of +0.1% qoq, or +0.2% yoy. Moreover, it is expected that the EU economy will continue accelerating in the rest of the year. At least, EU macro data published in May were better than expected, pointing to gradual gaining of the momentum. Thus, retail sales, industrial production and PMIs beat estimates, albeit insignificantly. In turn, services PMI and consumer confidence missed the consensus, insignificantly either. So, despite the ECB still believes that risks to economic growth is tilted to the downside, estimated recession probability has continued going down relatively fast recently, falling to only 30% in May, the lowest figure over more than two years. It was equal to 65% at the beginning of the year.
The 1Q24 earnings season was quite strong with notably better fundamentals across the board. Thus, more than 80% of the banks from our sample exceeded revenue expectations with the median surprise of 2.1%. In turn, more than 70% of banks reported higher EPS figures with the median surprise of +8.2%. Nonetheless, the earnings momentum continued deteriorating as growth of both revenue and operating income decelerated significantly in two recent quarters. Moreover, earnings visibility of EU banks is still quite uncertain. On the one hand, significant decline of key rates will inevitably hurt NIM/NII. On the other hand, lower rates mean faster growth of the EU economy, which implies higher loan growth, better fee income dynamics as well as stronger asset quality, which, accompanied by relatively high excess capital and more buybacks, will lead to faster EPS growth. In turn, back book yield has already begun going down. Thus, Eurozone’s average corporate loan yield (outstanding business) decreased by 1 bps MoM in March, the first month of decline over two years. In turn, total cost of deposits increased by 2 bps MoM. However, EU banks reported that their access to funding improved for majority sources in 1Q24, and banks expected that it continued improving in 2Q24. Moreover, the second derivative of both deposit and loan growth improved in recent months, despite rates remained elevated. But credit impulse still remained quite weak. Thus, corporate loans decreased by 0.3% yoy in April while consumer loans went down by 0.4% yoy. In any case, NII growth will be bleak in the near future. At least, FY25 NII has already decreased by 0.9% ytd, and it is expected that NII will be roughly flat on a yoy basis in the two nearest years. So, EPS estimates dynamics remained relatively weak ytd either, albeit growing recently. Thus, median EPS growth of our sample of banks was +2.8% ytd for FY24E but just +1.2% ytd for FY25E as of the end of May.
We still have remained neutral on EU banks currently but increasingly cautious. On the one hand, flat EPS dynamics does not imply any significant re-rating of EU banks despite valuations remains low even after substantial outperformance of the sector in two recent years. 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. However, a certain correction in the short-term doesn’t look unlikely, caused, for example, by profit-taking.
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