EU banks slightly outperformed the broad market in September, following underperformance in August. So, it was the second time of outperformance over the last three months and the 19th time over 26 months.
EXECUTIVE SUMMARY
EU banks slightly outperformed the broad market in September, following underperformance in August. So, it was the second time of outperformance over the last three months and the 19th time over 26 months. EU banks (the SX7P index) ended the month in the green, for the 9th time over the last 11 months. The index increased by 0.8% MoM in September vs -0.4% MoM of the broad market (the STOXX 600 index). The absolute September 2024 performance was just +0.05 std from the mean monthly performance, and it was in the bottom 48% of absolute performance in the index history. The relative September 2024 performance was +1.2% MoM. It is +0.3 std from the mean, and it is in the top 32% of relative performance in the history of the SX7P index. Overall, EU banks outperformed the broad market by 34.2% over the last 26 months, but just by 5.5% since February 2022 because of a significant decline in March 2023. Despite stronger dynamics in 2022/23 years, the SX7P index underperformed the broad market significantly in each of 2018-2020 years. Given still relatively weak economic projections, the start of the rate cut cycle and roughly flat EPS estimates qtd, more than 50% banks from our sample ended the month in the red, even despite the SX7P index increased slightly. Thus, Jyske Bank and Danske Bank – the worst performers of the month – decreased by 3.7% MoM and 4.3% MoM, respectively. In turn, the best performer – Commerzbank – surged by 23.5% MoM in September, driven by news that UniCredit increased its holdings in the bank to 9.0% from 4.5% previously. But the variability of monthly price changes increased slightly in September, for the first time over the last 6 months. Thus, the difference of monthly price changes between the best and the worst performers was 27.8% in September vs 14.4% in August and 29.6% in 2Q24. In turn, the correlation among EU banks between price changes ytd and EPS FY24E changes ytd decreased slightly in September, after a notable growth in August, still remaining lower vs US banks, but the gap has narrowed.
Despite notable outperformance in recent years, EU banks continue to trade at a significant discount both to historical averages and to the broad market as EPS estimates growth also remains quite high. Thus, the median P/E 24E of our group of banks decreased again, falling from 7.2x (as of September 2, 2024) to 7.0x (as of October 3). Similarly, the median P/E 25E went down from 7.0x (as of September 2, 2024) to 6.9x (as of October 3). But both ratios are not very far from their levels at the end of 2022. Nonetheless, banks are still trading at -1.47/-1.45 std on P/E CY and at -1.02/-0.99 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 EU broad market, banks are currently trading at -1.5 std from the sample mean (2010-current moment) for P/E CY and -1.3 std for P/E NY. Moreover, the discount to US banks also remains much wider than on average, staying at -1.5/-1.0 std for P/E CY/NY as of October 3. The median P/B of our group of banks also decreased slightly during the last month, sliding from 0.86x as of September 2, 2024 to 0.84x as of October 3. EU bank’s ROE figures over 2H23-1Q24 were the highest since the pre-GFC era, and it would remain quite high vs the average post-GFC ROE figures in the nearest years, albeit a few percent below current levels. As for individual names, multipliers still vary across the banks, but the dispersion has decreased recently. However, RBI’s P/E estimates for the nearest years remain just around 3x at the moment while UBS’s ratios range 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 7.1x.
The growth of the EU economy in 3Q24 was weaker than expected even despite the recent start of the rate-cutting cycle. We don’t expect any acceleration in GDP growth in 3Q24, especially following the quite weak September PMI data. Nonetheless, the ECB hopes that EU economic momentum will improve in the near future due to the start of the easing cycle. Moreover, the ECB’s central scenario of a consumer-led recovery remains intact albeit downside risks to economic growth are also intact. Nonetheless, the ECB lowered its GDP growth forecasts by 10 bps for the nearest years in the September projections. The good news is that inflation continues to decelerate – headline CPI fell to just 1.8% in September, the lowest level over more than 3 years, and now is below the ECB’s target, implying fewer restrictions on faster rate cuts. However, services inflation is still a concern for the regulator, but the probability of another rate cut at the upcoming meeting in October increased significantly after the release of the September PMIs. This is especially the case since another rate cut in October wasn’t completely ruled out by the ECB’s chair during the press conference after the September meeting. Thus, according to the current market expectations, we will see two rate cuts till the end of 2024 and 5 more till the end of next year, which implies the ECB’s facility rate of less than 1.8% by the end of 2025 compared to the expectations of around 2.9% as the end of May 2024. Given growth of macro risks both in the US and China as well as still high political uncertainty, it is definitely early to say that the EU economy is completely out of the woods, especially taking into account ongoing stagnation of the EU’s leading economy. Moreover, some of the problems of the German economy are structural in nature.
Fundamentals of EU banks remain strong but momentum continues weakening. The key event for EU banks in the next 2 months will be the 3Q24 earnings season which will be kicked off by the quarterly report of BG AV on October 14, 2024, but more than 60% of SX7P index members will report in the last decade of October. Given the recent start of the rate-cutting cycle, the rapid decline of interest rate expectations as well as still high both economic and political uncertainty, it seems that outlooks will be more important for investors than quarterly earnings by themselves, especially when it comes to NII forecasts. On the one hand, fundamentals of EU banks remain quite strong with a median ROE above 13% in 1H24, the highest level since the pre-GFC era. On the other hand, earnings momentum continued deteriorating, despite the resilience of the EU economy so far. Thus, 2Q24 was the 14th consecutive quarter of positive revenue growth on a yoy basis but the median growth of our sample of banks was just +3.1% vs around 20% yoy in 2Q23. NII even decreased by 1.5% in 2Q24 while fees went up by 8.5%. So, operating income was also negative in 2Q24, for the first time over more than three years. Nonetheless, EPS forecasts continued going slightly up even in 3Q24, despite the sharp rates decline. Earnings momentum was the key driver of EU banks’ outperformance in three previous years, but further profit growth now seems uncertain as revenue will remain roughly flat in the next two years, at least under current market expectations. In turn, OpEx will continue going up even in case of further inflation decline, implying growth of efficiency ratios and negative operating leverage. Asset quality is still quite strong but the flip side of the coin is risks of deterioration in case of worse economic growth. It doesn’t mean that the operating results of all EU banks will deteriorate/not improve in 2025/26 years, but a number of banks with positive profit growth will be limited with risks skewed to the downside. So, it seems that there almost no near-term drivers for EU banks left. Nonetheless, it doesn’t mean that EU banks will be inevitably sold off in the coming months, given still relatively low valuations as well as quite high capital buffers of EU banks. The latter along with high internal capital generation implies that the expected double-digit total yield is sustainable even in case of economic deterioration. But we recommend to be selective, preferring banks with a relatively high share of fee income. So, we still remain neutral on EU banks but gradually becoming more optimistic.
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