EU banks outperformed the broad market notably in October for the second consecutive month. So, it was the third time of outperformance over the last 4 months or the 20th time over 27 months. EU banks (the SX7P index) ended the month in the green, for the 10th time over the last 12 months.
EXECUTIVE SUMMARY
EU banks outperformed the broad market notably in October for the second consecutive month. So, it was the third time of outperformance over the last 4 months or the 20th time over 27 months. EU banks (the SX7P index) ended the month in the green, for the 10th time over the last 12 months. The index increased by 0.6% MoM in October vs -3.3% MoM of the broad market (the STOXX 600 index). The absolute October 2024 performance was just +0.03 std from the mean monthly performance, and it was in the bottom 45% of absolute performance in the index history. The relative October 2024 performance was +4.1% MoM. It is +1.1 std from the mean, and it is in the top 11% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 39.8% over the last 27 months, but just by 9.9% since February 2022 because of a significant drop in March 2023. Despite stronger dynamics in 2022/23 years, the SX7P index underperformed the broad market significantly in each of 2018-2020 years. Regardless of still relatively weak economic projections, the start of the rate cut cycle and roughly flat EPS estimates qtd, more than 60% banks from our sample ended the month in the green, driven by stronger 3Q24 earnings. Thus, the best performers – GLE FP, STAN LN and BPE IM – increased by more than 10% MoM in October. In turn, Jyske Bank (the second consecutive month among the worst performers) and Lloyds decreased by 8.3% MoM and 9.2% MoM, respectively. So, variability of monthly price changes increased notably in September and October, after 5 consecutive months of decline. Thus, the difference of monthly price changes between the best and the worst performers was 27.2% in October and 27.8% in September vs 14.4% in August, 29.6% in 2Q24 and 34.6% in 4Q23. In turn, the correlation among EU banks between price changes ytd and EPS FY24E changes ytd decreased significantly in October, falling by -33% MoM to just 24%, remaining much lower vs US banks.
Despite noticeable outperformance in recent years, EU banks continue trading with a significant discount both to historical averages and to the broad market as EPS estimates growth also remains quite high. Thus, median P/E 24E of our group of banks increased from 7.0x (as of October 3, 2024) to 7.3x (as of October 31). In turn, median P/E 25E went up from 6.9x (as of October 3, 2024) to 7.2x (as of October 31). But both ratios are not very far from the levels of the end of 2022. Nonetheless, banks are still trading at -1.29/1.27 std on P/E CY and at -0.89/-0.85 std on P/E NY (on the basis of samples from 2006 and 2010 years) relative to historical averages. As for valuations relative to the STOXX 600 index, EU banks are currently trading at -1.3 std from the sample mean (2010-current moment) for P/E CY and -1.1 std for P/E NY. Moreover, the discount to US banks also remains much wider than on average, at -1.3/-0.9 std for P/E CY/NY as of October 31. Median P/B of our group of banks also increased notably during the last month, rising from 0.84x as of October 3, 2024 to 0.96x as of October 31. ROE figures of EU banks in 2H23-1Q24 were the highest since the pre-GFC era, and ROE would remain quite high vs averages of the post-GFC period in the nearest years, albeit a few percent below current levels. As for individual names, multipliers are still quite different, but the dispersion across banks has decreased recently. Nonetheless, RBI’s P/E estimates for the nearest years remain just around 3x at the moment while UBS’s ratios are ranging from 18.4x for 2024 year to 8.5x for 2026 year, comparing to the industry’s average ratio for the nearest three years of 7.2x.
Growth of the EU economy in 3Q24 was stronger than expected even despite mixed signals from hard data. After quite weak September PMI figures we didn’t expect any acceleration of GDP growth in 3Q24, but the EU economy increased by 0.4% qoq vs the consensus of +0.2% qoq and the 2Q24 growth rate of +0.2% qoq. GDP growth rates in all key European economies, except for Italy, beat estimates in 3Q24, while Italian GDP remained unchanged qoq vs the consensus of +0.2%. The ECB hoped that a momentum in the EU would improve due to the start of the easing cycle. But it's too early for lower rates to have a positive effect on the economy, from our point of view. Moreover, the ECB even lowered its GDP growth forecasts for the nearest years by 10 bps in the September forecast. The good news is that inflation continues moving in the right direction with headline CPI remained near 2% in October, a tad higher than the lowest ratio over more than 3 years, implying fewer restrictions on faster rate cuts. On the other hand, interest rate expectations increased notably in October, even despite another cut at the last meeting. Thus, according to current market expectations, we will see one more rate cut in 2024 and at least 3 more till the end of 2025, which implies the ECB’s facility rate of lower than 2% at the end of 2025. In turn, EU macro data published in October were roughly in line with expectations even despite GDP surprise. The latter, however, once again confirms the validity of ECB's concerns about near-term economic recovery. At least, composite PMI remained below 50 pts for the second consecutive month in October, pointing to relatively weak economic recovery in 4Q24 while manufacturing PMI continued to be below threshold for the 28th month in a row. Nonetheless, estimated recession probability still remained relatively low, staying at 30% as of the end of October.
3Q24 earnings were better than expected, but the momentum continued weakening despite positive operating leverage. The beginning of the 3Q24 earnings season was quite strong for EU banks, at least for those which have already revealed results. The majority of them beat both net income and revenue estimates even despite raised guidance during 2Q24 earnings. Moreover, EU banks managed to exceed both forecasts and their own guidance even despite interest rate expectations decreased significantly since the previous outlooks were published. Thus, more than 80% of the banks from our sample that had already released results exceeded revenue expectations with a median surprise of 2.2% (vs +2.1% in 2Q24). More than 90% of banks reported higher EPS figures but with a median surprise of +10.9% (vs +7.7% in 2Q24). Despite a significant decline of interest rate expectations, NII was roughly in-line with consensus while fees were the main driver of stronger revenues. Thus, 3Q24 was the 15th consecutive quarter of positive revenue growth on a yoy basis, but a median growth of our sample of banks (which released 3Q24 results to date) was just +1.9% vs around 16% yoy in 2Q23. Nonetheless, NII of the same group of banks decreased by 3.6% in 3Q24 vs -0.9% in 2Q24, the second consecutive quarter of decline after 3 years of growth. It was mainly driven by NIM decline, which decreased both qoq and yoy despite all banks' efforts to hedge interest rate risk. In turn, non-interest income of the same group of banks increased by 7.9% yoy in 3Q24 vs +8.8% yoy in 2Q24, remaining the key profit driver of EU banks in the nearest quarters given NII headwinds. In turn, OpEx was lower than expected and well controlled even despite still elevated wage inflation. So, operating leverage of EU banks was again positive in 3Q24 after the first negative gauge over 14 quarters in 2Q24. Nonetheless, it doesn’t mean that earnings momentum, which was the key driver of EU banks outperformance in three previous years, will continue improving in the near quarters given current revenue growth expectations. At least, FY25 EPS estimates continued going down even despite much stronger results in 3Q24. So, earnings visibility of EU banks is still uncertain while risks to EU economic growth remain tilted to the downside. On the other hand, EU banks remain cheap with high internal capital generation, which implies that expected double-digit total yield is sustainable even in case of economic deterioration, which, in turn, implies limited risks of significant sell-offs, at least all other things being equal. So, we still remain neutral on EU banks, but gradually becoming more optimistic.
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