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  • Writer's pictureArbat Capital

EU Banking Sector Report - May 2024

EU banks outperformed the broad market again in April, for the third consecutive month. Moreover, it was the 16th time of outperformance over the last 21 months. Also, EU banks (SX7P index) ended the month in the green, for the 15th time over the last 19 months. The index increased by 2.9% MoM in April vs -1.5% MoM of STOXX 600 index.



EXECUTIVE SUMMARY


EU banks outperformed the broad market again in April, for the third consecutive month. Moreover, it was the 16th time of outperformance over the last 21 months. Also, EU banks (SX7P index) ended the month in the green, for the 15th time over the last 19 months. The index increased by 2.9% MoM in April vs -1.5% MoM of STOXX 600 index. Absolute April 2024 performance was +0.4 std from the mean monthly performance, and it was in the top 36% of absolute monthly performance in the index history. Relative April 2024 performance was +4.5% MoM. It is +1.2 std from the mean monthly performance, and it is in the top 9% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 33.8% over the last 21 months, but just by 5.2% 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 April, it was already 6.3% higher than at the end of 2017, but still underperforming STOXX 600 index by 18% over this period. Despite still relatively weak economic projections, upcoming start of the rate cut cycle and roughly flat EPS estimates ytd, more than 60% of our sample of banks ended the month in the green, mainly driven by better 1Q24 earnings and encouraging 2024 outlooks.  Nonetheless, variability of monthly price changes decreased noticeably in April, even despite the start of the earnings season. Thus, a difference of monthly price changes between the best and the worst performers was 35.9% in April vs 50.7% in March 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 increased again in April, for the second consecutive month. UBS still remains the biggest outlier even after a significant decline of its quotes within the month under review.

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 quite high. Thus, median P/E 24E of our group of banks increased from 7.1x (as of March 29, 2024) to 7.4x (as of May 3). In turn, median P/E 25E went up from 6.9x (as of March 29, 2024) to 7.1x (as of May 3). So, both ratios have already returned back to levels of the end of 2022. Nonetheless, banks are still trading at -1.3/-1.3 std on P/E CY and at -0.9/-0.9 std on P/E NY (on the basis of samples from 2006 and 2010 years) relative to historical averages. As for relative valuation to STOXX 600 Index, EU banks are currently trading at -1.3 std from the sample mean (2010-current moment) for P/E CY and -1.0 std for P/E NY. Moreover, their discount to US banks also remains much wider than on average, staying at -1.3/-0.9 std for P/E CY/NY as of May 3. Median P/B of our group of banks also increased during the last month from 0.84x as of March 29, 2024 to 0.88x as of May 3. 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 the 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 3.2-3.3x while UBS’s ratios are from 26x for 2024 year to 7.8x for 2026 year and industry’s average ratio for the next three years is 7.2x.

The EU economy continues to move in the right direction with gradually improving momentum and lower inflation. Despite still very tight financial conditions and relatively high geopolitical uncertainty, GDP growth exceeded consensus estimates in 1Q24. And the beat was broad-based across the largest EU economies. 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, and the 4Q23 growth rate of -0.1% qoq, but +0.1% yoy. Even German GDP turned positive again on a qoq basis, adding +0.2% qoq, but still -0.2% yoy, negative on a yoy basis for the 4th consecutive quarter. Moreover, it is expected that the EU economy will continue accelerating in the rest of the year. On the other hand, estimated recession probability still remained relatively high but decreasing, staying at 40% in April – the lowest figure over the last year. But it was 65% at the beginning of this year. In turn, EU macro data published in April weren’t definitely strong again even despite higher 1Q24 GDP figures. Thus, retail sales, industrial production and consumer confidence missed estimates, albeit insignificantly. In turn, composite PMI exceeded consensus, driven by the services index. Inflation on a yoy basis decreased slightly again in April, and headline figures were slightly lower than expected ytd. Moreover, PPI remains negative on a yoy basis for the 11th consecutive month. Lower inflation accompanied by decelerating wage growth is the necessary condition for the ECB to begin the rate cut cycle. Nonetheless, the ECB will not rush to lower rates, given higher growth of the EU economy. So, interest rate expectations increased notably ytd and soared again in April. It is expected currently that the easing cycle will start only in June with total cut of just 75 bps in 2024 vs more than 150 bps just 3 months ago.

Start of the 1Q24 earnings season was strong for EU banks with better EPS/ revenue figures and still quite high profitability ratios as well as total capital returns. Thus, more than 80% of the banks from our sample that had already released results exceeded revenue expectations with a median surprise of +2.1%. Around 60% of banks reported higher than expected EPS figures, but with a median surprise of +7.5%. Unsurprisingly, market perception of the results was optimistic with continued outperformance of EU banks in April and upward revisions of estimates. Due to skyrocketing rates growth in recent years, ROE of EU banks reached the highest level since the pre-GFC era, exceeding 13% during three recent quarters. NII and NIM were the key drivers of quite strong profit dynamics until so far but their growth decelerated substantially in 1Q24, back to single-digit rates for the first time in 2 years. Moreover, further NII/NIM dynamics look challenging given upcoming start of the rate cut cycle and still relatively weak growth of the EU economy. So, even 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. Nonetheless, EU banks reported that their access to funding improved for majority sources in 1Q24. Moreover, the second derivative of both deposit and loan growth improved in recent months. However, ROE will inevitably decline in the near future, but it will remain double-digit, staying well above post-GFC averages. In turn, earnings momentum continued deteriorating. Thus, growth of both revenue and operating income decelerated significantly in two recent quarters. But it was the 13th quarter of positive yoy revenue growth in a row, albeit days of a double-digit growth have already been behind us. So, it is still expected that revenue growth will remain positive in 2024. And capital returns keep on being quite high with double-digit expected annual capital returns at least for the next two years, providing to shareholders well above €100 Bn only in 2024. Earnings visibility continues improving while uncertainty about future quotes dynamics is gradually growing, given recent outperformance. So, we still remain neutral on EU banks currently but increasingly cautious.


AC - EU Banking Sector Report - May-2024
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