EU banks outperformed the broad market slightly in February, for the first time over the last three months. Moreover, it was the 14th time of outperformance over the last 19 months. Also, SX7P index ended the month in the green, for the 13th time over the last 17 months.
EXECUTIVE SUMMARY
EU banks outperformed the broad market slightly in February, for the first time over the last three months. Moreover, it was the 14th time of outperformance over the last 19 months. Also, SX7P index ended the month in the green, for the 13th time over the last 17 months. The index increased by 2.1% MoM in February vs +1.8% MoM of STOXX 600 index. Absolute February 2024 performance was +0.3 std from the mean monthly performance, but it was in the top 43% of absolute monthly performance in the index history. Relative February 2024 performance was +0.3% MoM. It is +0.1 std from the mean monthly performance, and it is in the top 44% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 21.7% over the last 19 months, but just by 6.7% since the end of 2022 because of a 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, it is still 5.2% lower than it was at the end of 2017, underperforming STOXX 600 index by 25.4% over this period. Despite still weak economic projections and mixed 4Q23 earnings season, more than 65% of our sample of banks ended the month in the green, mainly driven by positive 2024 outlooks. The key driver of quotes growth so far – strengthening of EPS estimates – is gradually slowing down, which is generally confirmed by the last earnings seasons. Unsurprisingly, variability of monthly price changes increased noticeably in February, driven by 4Q23 earnings season. Thus, a difference of monthly price changes between the best and the worst performers was 31.9% vs 21.7% in January. However, correlation among EU banks between price changes ytd and EPS FY24E changes ytd decreased significantly in the first two months of the year, mainly driven by investor reaction on the 4Q23 earnings. Due to its significant growth in 4Q23, UBS remains the biggest outlier as its EPS estimates decreased significantly. Thus, the quotes of UBS increased by 23% yoy as of the end of February while its FY24 EPS estimate was revised down by 61% 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 solid. Thus, median P/E 24E of our group of banks increased from 6.1x (as of February 8, 2024) to 6.6x (as of March 6). In turn, median P/E 25E went up from 6.2x (as of February 8, 2024) to 6.6x (as of March 6). Both ratios remained noticeably lower vs the end of 2022. So, banks are still trading at -1.7/-1.7 std on P/E CY and at -1.3/-1.2 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 -1.7 std from the sample mean (2010-current moment) for P/E CY and -1.1 std for P/E NY. Moreover, a discount to US banks also remains much wider than on average, -1.8/-1.4 std for P/E CY/NY as of March 6. Median P/B of our group of banks also increased during the last month, expanding from 0.70x as of February 8, 2024 to 0.86x as of March 6. 4Q23 ROE was the highest one 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 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 4x while SHBA’s average P/E ratio is around 10x and industry’s average P/E ratio is 6.4x. In turn, an average discount of P/E of British banks to P/E of other EU banks is more than 30%, much higher than historical averages.
EU Macro data released in February wasn’t strong again but there are more and more signs of bottoming out of the EU economy, even despite ongoing sluggishness of the German economy. So, the EU economy continues gradually gaining momentum albeit quite slowly. 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. However, risk of falling into recession still remains high albeit decreasing in recent months. Thus, EU macro data published in February wasn’t strong again with slightly worse than expected retail sales but slightly higher services PMI and significantly higher industrial production. Also, the labour market continues gradually cooling, accompanied by slowing wage growth. The latter is 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. So, interest rate expectations increased notably ytd. And it is already expected that the easing cycle will start only in 2Q24 with total cut of less than 100 bps in 2024 (as of the end of February) vs expectations of more than 150 bps cut just a months ago. Given recent credit data and PMI figures, high rates have had a limited effect on the EU economy so far. The bad news is that the lagged effects of quite restrictive interest rates may well surprise us with a minus sign in the nearest future. At least, EU manufacturing activity still remained quite weak while the emerging turnaround of the EU economy may quickly be replaced by a new fall if rates remain at a high level for longer than necessary. So, risks are still tilted to the downside.
The 4Q23 earnings season wasn’t strong for EU banks, but profitability remained at a multi-decade high. Thus, less than a half of the banks from our sample exceeded revenue expectations with a median surprise of -0.5%. Only around 60% of banks reported higher EPS figures, but estimates had been cut notably before. Moreover, the earnings momentum continued deteriorating. Thus, growth of both revenue and operating income decelerated significantly in 4Q23. Nonetheless, 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, even despite weaker 4Q23 reported figures. Interest rates were the key driver of EU banks revenue growth for a long time, but now the times have changed as the ECB’s rate hike cycle is over and the first rate cut is already expected as early as in 2Q24. However, the rate cut cycle will be much smoother than expected at the end of 2023. Hence, asset yields have already started to decline while cost of funding still continues going up. Thus, Eurozone’s average corporate loan yield (new business) decreased by 1 bps MoM in January, the third consecutive month of decline. In turn, total cost of deposits (new business) increased by 5 bps MoM. Moreover, credit impulse still remained quite weak albeit the second derivative of both deposit and loan growth improved slightly in recent months. Hence, taking into account that the yield curve will remain inverted in the nearest quarters and a further decline of rate expectations, we expect that NII growth will be bleak in 2024. The NII tailwind has already disappeared while credit quality continues going up, and it means relatively high probability of EPS/revenue estimates downgrades in the near term. In other words, uncertainty remains high, and the 4Q23 earnings season hasn’t convinced investors otherwise. Restrained market reaction to 4Q23 results only confirms this, from our point of view. A scenario of EPS downgrades does not imply any significant re-rating of EU banks even despite quite low valuations after their substantial outperformance in 2023. On the other hand, we don’t expect substantial decline of EU banks either, given still positive and improving GDP growth, quite low 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.