European banks hailed as top contrarian trade
Citi sees risks as ‘selective,’ not ‘systemic’
It’s being called the “world’s biggest contrarian trade” — a bet on European banks — and now is the time to make it, according to Citi Research.
Euro area banks rank at the very bottom of 285 regional and sector combinations Citi tracked in the past 10 years, and Europe (ex U.K.) and U.K. banks also fell in the bottom five.
But with macroeconomic risks trending downward as a result of benign commodity markets, lower sovereign risk and a shift toward more synchronized growth, analyst Jonathan Stubbs is telling clients to get overweight banks in Europe.
“European banks have been a value trap, similar to emerging markets and commodities,” he said. “To move from value trap to value trade, risks need to reduce. We think that is happening.”
The next step to a momentum trade requires fundamental improvement, a shift Stubbs thinks is less clear.
He acknowledged t he headwinds face European banks, i ncluding regulatory issues, negative interest rates pressuring profits, weak real estate prices and elevated political risks.
Despite the recent recovery, the sector still trades at a roughly 30-per-cent-plus discount to the rest of the market on a relative P/E basis.
European banks al s o trade at approximately 4.8x on a price to gross operating profit basis. That compares to the long- term average of 5.7x.
“The cheapest European banks have never been cheaper relative to the expensive European banks,” Citi said.
Meanwhile, consensus earnings revisions have pre- dominantly been negative in the past three months.
But the negatives are being offset by better loan growth, an improving credit cycle and improving returns.
Stubbs noted that U.S. banks have done a better j ob than their European counterparts at fixing balance sheets and rebuilding business models following the financial crisis.
Yet the analyst believes bank risks in Europe have shifted from “systemic” to “selective,” in that the sector has more capital, less leverage and more policy support.
“The system appears stronger with risks possibly now transferred to over- aggressive regulation,” he said.
So with European banks trading at the cheapest level ever relative to U.S. banks, Stubbs has found several names that look attractive.
He highlighted Spain’s BBVA SA, U. K.-based Standard Chartered PLC, Danske Bank A/ Sin Denmark, and Belgium’ s KBC Groep NV.
Citi also recommends Intesa SpA in Italy, France’s BNP Paribas SA and Holland-based ING Groep NV.
Germany’s Deutsche Bank didn’t make the cut, as questions loom about its financial stability.
The U. S. Department of Justice i s demanding as much as US$ 14 billion in settlement relating to improper sales of mortgagebacked securities by Germany’s largest bank prior to the 2008- 2009 financial crisis.
Investors appear to be giving the bank the benefit of the doubt in recent days, but its woes continue to mount as Italian authorities charged some current and former managers for falsifying accounts at Monte Dei Paschi.
Deutsche Bank’s troubles also suggest that regulatory scrutiny will not ease anytime soon.
On Thursday, International Monetary Fund managing director Christine Lagarde said Deutsche Bank and many other big banks, must re- evaluate their business models.
“( It must) decide what size it wants to have and how it wants to strengthen its balance sheet,” she said. “But it’s not the only one in the banking basket that has to do that job.”