EU banks underperformed the broad market significantly in August after their outperformance in July. So, it was the second time of underperformance over the last three months but just the 7th time over 25 months. EU banks (SX7P index) ended the month in the red, only for the second time over the last 10 months.
EXECUTIVE SUMMARY
EU banks underperformed the broad market significantly in August after their outperformance in July. So, it was the second time of underperformance over the last three months but just the 7th time over 25 months. EU banks (SX7P index) ended the month in the red, only for the second time over the last 10 months. The index decreased by 1.8% MoM in August vs +1.3% MoM of the broad market (STOXX 600 index). Absolute August 2024 performance was -0.3 std from the mean monthly performance, and it was in the bottom 32% of absolute performance in the index history. Relative August 2024 performance was -3.1% MoM. It is -0.8 std from the mean performance, and it is in the bottom 16% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 32.7% over the last 25 months, but just by 4.3% since February 2022 because of significant decline in March 2023. Despite stronger dynamics in 2022/23 years, SX7P index underperformed the broad market significantly in each of 2018-2020 years. Due to still relatively weak economic projections, the start of the rate cut cycle and roughly flat EPS estimates ytd, more than 70% banks from our sample ended the month in the red, driven by profit taking in early August as well as weaker earnings of banks, which announced results recently. And declines of the worst performers of the August were significant. Thus, Societe Generale and Commerzbank decreased by 9.0% MoM and 11.3% MoM in August, respectively. In turn, the best performers – BAER SW and EBS AV – increased just by around 3% MoM in August. Nonetheless, variability of monthly price changes decreased again in August, for the 5th consecutive month, even despite continuation of the earnings season. Thus, a difference of monthly price changes between the best and the worst performers was 14.4% in August vs 22.3% in July. Even correlation among EU banks between price changes ytd and EPS FY24E changes ytd increased notably in August, for the first time over the last 4 months, still remaining lower vs US banks, but the difference was not so big anymore by the end of August.
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 again, rising from 6.7x (as of August 8, 2024) to 7.2x (as of September 2). In turn, median P/E 25E went up from 6.6x (as of August 8, 2024) to 7.0x (as of September 2). But both ratios are not very far from levels of the end of 2022. Nonetheless, banks are still trading at -1.38/1.37 std on P/E CY and at -0.96/-0.93 std on P/E NY (on the basis of samples from 2006 and 2010 years) relative to historical averages. As for valuations relative to STOXX 600 index, the 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, -1.4/-0.9 std for P/E CY/NY as of September 2. Median P/B of our group of banks also decreased slightly during the last month, falling from 0.8x as of August 8, 2024 to 0.86x as of September 2. ROE in 2H23-1Q24 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. However, RBI’s P/E estimates for the nearest years remain just around 3x at the moment while UBS’s ratios vary from 18.4x for 2024 year to 8.4x for 2026 year comparing to industry’s average ratio for the nearest three years of 7.0x.
Growth of the EU economy still continues accelerating even despite slowing momentum in the global economy. Against all recent fears, the EU momentum should even improve, at least near term, due to the start of ECB’s easing cycle. Moreover, we expect that the start of the easing cycle by the Fed will give an additional boost to the ECB to cut rates faster even in case of resilience of inflation. By the way, the latter continues moving in the right direction – headline CPI decreased to just 2.2% in August, the lowest ratio over more than 3 years, just a bit above ECB’s target. However, services inflation is still a concern for the regulator. So, the wording about inflation in the July statement remained cautious. Nonetheless, rate expectations decreased noticeably in recent months. Thus, according to the current market expectations, we will see less than 4 cuts with total decline of around 100 bps in 2024 (2-3 more till the end of the year with almost imminent decline at the nearest meeting in September) vs expectations at the beginning of 2024 of almost 7 rate cuts with total cut of around 170 bps. On the other hand, recession probability increased slightly in July to 30% from 20% in June vs 65% at the beginning of the year while macro risks both in US and in China continued going up recently. Moreover, EU macro data published in August were slightly worse than expected again, confirming that the recovery is still pretty fragile. Unsurprisingly, ECB still believes that risks to economic growth are tilted to the downside. Definitely, it is too early to say that the EU economy is completely out of the woods given a notable growth of political uncertainty, but the baseline scenario is still intact – gradual accelerating of the recovery.
2Q24 earnings were strong across the board but new catalysts are required for further growth. Thus, more than 90% of banks from our sample exceeded revenue expectations with a median surprise of +2.1%. More than 85% of banks reported EPS figures above consensus with a median surprise of solid +7.2%. Higher-than-expected net income was mainly driven by better fee income and still strong asset quality while NII figures were roughly in-line with expectations due to higher-for-longer interest rates environment, at least until so far. Nonetheless, despite better both 2Q24 earnings and improved FY24 outlooks, EU banks performance was relatively weak since the start of the earnings season as a result of profit taking, driven by growth of global macro risks, still high political uncertainty as well as expected faster rate cuts. In other words, the earnings momentum continued deteriorating, despite steady acceleration of the EU economy. Thus, 2Q24 was the 14th consecutive quarter of positive revenue growth on a yoy basis, but a median growth of our sample of banks was just +3.1% vs around 20% yoy in 2Q23. In turn, NII even decreased by 1.5% in 2Q24 while fees went up by 8.5%. So, operating income was also negative, for the first time over more than three years. Given ongoing growth of OpEx, operating leverage turned negative in 2Q24 either, for the first time over the last 14 quarters. Given a notable decline of rate expectations recently, new catalysts/drivers are needed for EU banks. But in any case, such a broad-based driver for EU banks as a growth of interest rates in the previous two years will not be found in the near future. Moreover, if rates continue to decline as fast as they do currently, they will clearly become a headwind for EU banks in the nearest quarters. Also, recession fears are still quite high and even growing recently, especially after the latest macro data from US and China. So, a drop of quotes after credit quality misses is still much higher than a growth after lower than expected provisions, for example. However, fundamentals of EU banks remain quite strong with median ROE above 13% in 1H24, the highest level since the pre-GFC era. On the other hand, we don’t expect any significant growth of EU banks revenue in the nearest two years, which also implies limited profit growth. Moreover, risks of EPS decline have increased recently but still look constrained, from our point of view. So, stock picking is becoming more and more important within the industry. And even despite to already attractive levels from a risk-reward point of view, we still remain neutral on EU banks, expecting better entry point.
Comments