Banco Santander: Record H1 Results Met With A Cheaper Valuation

seekingalpha08-09

Shares of multinational banking giant Banco Santander have been a little soft since my last update, trailing European financials by around ten points in that time.Results for the first half of the ...

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World photo/iStock Editorial via Getty Images This has been a slightly frustrating few months for investors in Banco Santander (NYSE:SAN), whose shares have underperformed broader European financials (EUFN) by around ten points since my last update in April. Frustrating because, at the business level at least, Santander has continued its fine start to 2024, posting record half-year figures throughout its income statement. Data by YCharts Santander is arguably defined by its sprawling geographic footprint. While some of its operations, like in Spain, are basically at peak earnings for this cycle, others, like its Brazilian business, are still kicking back into gear following a slump. This intrinsic characteristic of the bank should help keep earnings relatively stable. On top of that, a combination of management actions and positive longer-term Eurozone interest rates can help limit some of the downside to its domestic business, with that leading to an overall step-up in structural profitability for the bank. With that, Santander remains nicely on track with respect to management's medium-term target of earning a 15-17% return on tangible equity (\"ROTE\"), yet the stock's recent fall means it has slipped even further below tangible book value. Quick math implies a P/E of around 5x at the mid-point of that ROTE target, or a circa 20% earnings yield to flip that number on its head. With this pointing to double-digit annualized returns simply via dividends and buybacks, I remain happy to leave my longstanding 'Buy' rating unchanged. Record Results Santander followed up a strong first quarter by posting record results for the first half. Net interest income (~€23.5 billion), fee income (~€6.5 billion) and profit attributable to the parent (~€6.1 billion) all hit record levels, with the bank posting its strongest cost/income ratio (~41.6%) in fifteen years. Return on tangible equity (\"ROTE\") of 15.9%, or 16.3% after annualizing the Q1 Spanish banking levy, remains comfortably within management's medium-term target range of 15-17%. Source: Banco Santander Q2 2022 Results Release As most investors here know, Santander's different geographies are often pulling in their own various directions. Spain (~25% of H1 earnings) remains in a nice purple patch, with NII up over 15% year-on-year in the first half to €3.65 billion. ROTE in the Spanish business was a touch over 20% in H1, up around seven points on the same period a year ago. The Brazilian business continues its recovery on the back of lower interest rates there, with first-half net income up nearly 40% to €1.1 billion and ROTE expanding by ~380bps to over 15.8%. This helped offset some of the weaker parts of Santander's empire, with the U.K. business, for example, seeing first-half net profit (down 23% to €630 million) and ROTE (down ~300bps to ~10.8%) come under pressure from higher funding costs, ongoing mortgage margin pressure and elevated operating costs. Last quarter saw the Eurozone's first interest rate cut of this cycle. Santander's Spanish business has been transformed by higher interest rates, with that 20% ROTE print around fourteen points higher than back in H1 2022 (when Eurozone rates were still negative). Readers would be forgiven for assuming that rate cuts are now a major headwind. A couple of points are worth noting on this. Firstly, management has hedges in place to lock in some of the benefits of prevailing conditions, basically reducing NII sensitivity to interest rates. Secondly, it is important to put interest rates and the Spanish business into recent historical context. While interest rates are indeed seen heading lower, Euribor is still above 2% across the curve, and that is a far cry from the sub-0% that Eurozone banks had to contend with before this cycle began. This will hopefully map to a structural step-up in profitability for the Spanish business, even though NII and ROTE are likely to drop off from current levels. Just to add a bit more color to the above, I mentioned last time that Santander averaged a circa 11% ROTE between 2015 and 2021. This was achieved with the Spanish business only generating a circa 8% average annual ROTE. So, there is plenty of scope for both of those figures to normalize upwards even if current Spanish earnings trend down. Data Source: Banco Santander Annual and Quarterly Results Releases There appears to be little to worry about elsewhere. Cost control looks solid, with operating expenses up 3.5% in the first half to €12.9 billion. That was against inflation that was still in the 4% area last quarter, so costs were actually down a touch in real terms. Furthermore, Santander has been beefing up its corporate & investment banking (\"CIB\") offering, with CIB seeing around 20% OpEx growth in H1. The bank's global retail & commercial segment, which drives around half of total earnings, is probably more indicative of underlying cost performance, with ~0.8% growth there pointing to a circa 3% fall in real terms overall. Credit quality similarly looks solid. Provisioning expenses landed at €6.2 billion, or around 117bps of total loans on an annualized basis. This is virtually in line with the ~120bps that management targets through the cycle. Unlike some European peers, I'm hoping this line won't provide much of a headwind to longer-term profitability. Non-performing loans fell around 8bps sequentially last quarter to 3.02%, with Brazil powering most of that, as expected previously. Valuation Santander reported tangible book value (\"TBV\") of €4.94 per share (~$5.39 per ADS) at the end of last quarter, up around 8% year-on-year. The ADSs, however, have slipped around 8% since prior coverage, with Santander's P/TBV multiple contracting from around 0.95x to around 0.80x as a result. This now looks very cheap to me. Management has slightly upped 2024 profitability guidance on the back of H1 results, now expecting the bank to earn a greater than 16% ROTE (versus just 16% previously). Dividing that into a 0.8x P/TBV multiple implies that the shares trade for just 5x earnings, which, to flip it on its head, equates to a 20% earnings yield. Capital returns are set at 50% of net income (split equally between dividends and buybacks), so investors are basically getting 10% per annum returned in cash. Given the implied level of retained earnings, management shouldn't have any problem in delivering its other goal of double-digit though-the-cycle growth in TBV per share plus dividends. This again points to double-digit annualized returns for investors even on a flat P/TBV multiple. This isn't purely a theoretical exercise. Santander has delivered a total return of around 66% since I opened on it back in early 2022, most of which has come from TBV per share growth and reinvested dividends: Data by YCharts Summing It Up  Shares of Santander have been a little soft since my last update, underperforming European financials, even though results at the business level have been just fine. Profitability in its core Spanish market is likely to come under some pressure now that Eurozone interest rates are falling, albeit this will be a gradual process and is not a significant cause for concern given how depressed this business was a few years ago. Meanwhile, these shares trade for just 5x earnings and offer investors a double-digit return from dividends and buybacks alone. I leave my 'Buy' rating unchanged.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2458588607"}