Company Reports

Despite the increased political risks, 4-star-rated BNP remains one of our top picks in the European banking sector, trading at a 26% discount to our fair value estimate. BNP trades at a 40% discount to the European banking sector's average price/tangible book ratio and it offers a juicy 7.5% dividend yield. While we expect BNP's midcycle profitability to lag the sector somewhat, we do not believe it justifies such a steep discount, especially if we consider BNP's remarkable historical earnings stability. France contributed only about 25% of BNP's revenue in 2023, compared with 40% for Societe Generale and 46% for Credit Agricole. BNP has deployed some excess capital into several small bolt-on acquisitions that should support incremental earnings growth. The increased volatility in European capital markets due to the French elections may be a positive for BNP's investment banking franchise as its clients will look to hedge risks on rates and currency, supporting volume, and wider spreads will support trading margins.

Credit Agricole S.A. is, in many ways, unique among European banks. It has a more diverse mix of operations. Its lower reliance on traditional banking activities reduces its exposure to credit and interest-rate risk, which could support greater earnings stability. But, it also means Credit Agricole S.A. stands to gain less from the return to positive interest rates. The relationship with its parent, the Credit Agricole Group, is a double-edged sword. It creates cross-selling opportunities but makes Credit Agricole S.A. a complex bank to understand.

Credit Agricole's fourth-quarter 2023 net profit declined year on year and quarter on quarter. Results also fell short of consensus estimates. Adverse weather conditions significantly hit its insurance operations, leading to a 47% year-on-year decline in revenue in its insurance division and depressing overall revenue growth. Certain charges Credit Agricole views as nonrecurring led to higher expenses. It remains on track to achieve 2025 growth and profitability targets. Our fair value estimate remains steady at EUR 14.50 per share and we retain our no moat rating.

No-moat Credit Agricole posted a 29% year-on-year increase in attributable net income for the third quarter of 2023; earnings also came in 28% ahead of the company-compiled consensus estimate. Credit Agricole has more minor exposure to French retail banking than its listed French peers. As such, its results suffered less from the regulated nature of French mortgage and deposit interest rates, which has constrained the revenue growth of its peers.

The most damaging impact of the surprise windfall tax announcement by the Italian government will not be the hit to the earnings of Italian banks, but the higher risk premium that investors will demand to compensate them for the risk of future government intervention. The haphazard manner of the announcement, where the government changed the terms of the tax at least three times in one day, will do little to restore investor confidence. Many investors already view European banks as seminationalised institutions, and we believe this goes a long way to explain the continued steep discount that European banks trade at relative to the broader market. Following a similar windfall tax in Spain and a ban on dividend payments during the coronavirus pandemic, investors will be even more concerned about the risk of arbitrary intervention from governments and regulators. We do not expect other major European governments to follow Italy and Spain, especially after seeing the fallout from the Italian debacle. We estimate that the hit to FactSet 2023 consensus earnings estimates will be 10% for Intesa Sanpaolo and 6% for UniCredit. BNP Paribas and Credit Agricole are the other European banks we cover with the most significant exposure to Italy. We calculate that the impact on group earnings for both would be below 2%. We do not plan to change our fair value estimates for BNP Paribas (EUR 76/share) and Credit Agricole (EUR 14.50/share). We have not resumed coverage of Intesa Sanpaolo and UniCredit yet.

No-moat Credit Agricole posted very strong results for the second quarter of 2023, with attributable net income of EUR 2 billion, 25% higher than a year earlier and materially ahead of the EUR 1.4 billion company-compiled consensus. Credit Agricole's investment banking business performed much better than anticipated and bucked the declining revenue trend of its peers. Credit Agricole is now on track to reach its EUR 6 billion net income target two years ahead of schedule. Credit Agricole's management did not provide detailed and updated guidance. We understand this. Investment banking revenue is at an all-time high for Credit Agricole and, in a low-volatility environment, could be under pressure in the future. Management indicated that it expects the recovery of French retail net interest margins to only start in the second half of fiscal 2024. We maintain our EUR 14.50 per-share fair value estimate.

We resume coverage of Credit Agricole S.A. with a no-moat rating and a fair value estimate of EUR 14.50 per share; its current share price implies a 25% discount to our fair value. It trades at 0.8 times its 2022 tangible book value, in line with its average market rating over the past decade, but at 7 times its 2023 earnings, its forward PE ratio is meaningfully below its 9 times long-term average. Credit Agricole S.A.’s valuation is in line with the average European bank that we cover. Given its lower interest rate sensitivity, Credit Agricole S.A. could be an interesting option for investors with a more dovish view on interest rates and investors with a broader allocation to European banks could consider including Credit Agricole S.A. as a natural hedge in their portfolio to offset the rate sensitivity of other European banks.

Credit Agricole S.A. is, in many ways, unique among European banks. It has a more diverse mix of operations. Its lower reliance on traditional banking activities reduces its exposure to credit and interest-rate risk, which could support greater earnings stability. But, it also means Credit Agricole S.A. stands to gain less from the return to positive interest rates. The relationship with its parent, the Credit Agricole Group, is a double-edged sword. It creates cross-selling opportunities but makes Credit Agricole S.A. a complex bank to understand.

We are dropping coverage of some of our European banks and asset managers. We will no longer be reporting on Santander, Credit Agricole, Julius Baer, Unicredit, Intesa Sanpaolo, Mediobanca, Amundi, KBC, DWS Group, BBVA, and Schroders. We provide broad coverage of more than 1,500 companies globally and periodically adjust our coverage according to investor interest and staffing.

The direct exposure of European banks to Russian and Ukrainian clients is insignificant. According to the Bank for International Settlements, claims on Russian counterparties from the major developed European countries' banks amount to 0.7% of the European banks' total claims reported to the BIS.

No-moat Credit Agricole reported pretax profits of EUR 2.1 billion for the third quarter of 2021, a 27% year-on-year increase and 14% higher than the EUR 1.9 billion the consensus collected by Credit Agricole had penciled in for the quarter. Loan loss provisions came in 40% lower than expected, and this was the main driver of the earnings beat. The 56% year-on-year decline in loan loss provisions was also the main driver of earnings growth. Expenses grew at 9% year on year, outstripping revenue growth of 7%. We maintain our EUR 15 per share fair value estimate and our no-moat rating.

No-moat Credit Agricole reported net attributable profits of EUR 2 billion for the second quarter of its 2021 fiscal year, more than double the EUR 954 million it reported for the second quarter of 2020 and 58% higher than the EUR 1.2 billion the consensus of analysts collected by Credit Agricole itself predicted. Revenue grew by 19% year on year, due to especially robust growth in the asset-gathering business of insurance and asset management. Revenue came in 9% ahead of consensus expectations. Operating cost growth was contained to 7%, leading to a 39% increase in preprovision profit. Loan-loss provisions declined by 67%, coming in 43% lower than consensus expectations. We maintain our EUR 15 per share fair value estimate and no-moat rating.

The head of supervision at the European Central Bank, or ECB, Andrea Enria recently confirmed the bank would lift the ban on dividends and share buybacks that it imposed on eurozone banks in March last year. Eurozone banks will now be able to resume returning capital to shareholders at the end of third-quarter 2021. The market widely expected the lifting of the ban, so we do not believe it will have a material near-term impact on the valuation of eurozone banking shares. As banks start reporting second-quarter earnings and the market gets a better idea of the extent of capital returns there may be more support for share prices. The European banking authorities will announce the results of their stress tests at the end of July. This will also provide investors with a better idea of which banks are best placed to return capital to shareholders.

We increase our fair value estimate for Credit Agricole to EUR 15/share from EUR 10/share previously. The sharp increase is the result of the more bullish view we have taken on Credit Agricole’s cost of equity, which we have lowered to 9.5% from 11.5% previously. Under our new capital allocation framework, we also now rate Credit Agricole’s capital allocation as Standard compared with the Poor rating it held under our previous stewardship methodology. We maintain our no moat rating.

Credit Agricole is looking to grow its asset-gathering and consumer finance businesses ahead of the rest of the group. We believe this is the correct approach; these are the most profitable areas of the group and as such these will support higher future profitability. Credit Agricole will however, keep a significant exposure to volatile and capital-intensive corporate and investment banking; it allocates around 33% of its capital to this division.

No-moat Credit Agricole reported net attributable profits of EUR 1 billion for the first quarter of its 2021 fiscal year, a 64% year-on-year increase over the EUR 638 million it reported for the first quarter of 2020 and 51% more than the EUR 694 million the consensus of analysts collected by Credit Agricole itself anticipated. In contrast to many of its European banking peers Credit Agricole's earnings growth was not solely due to lower loan-loss provisions. Robust revenue growth and a decline in operating expenses also supported a 21% year-on-year increase in first-quarter preprovision profits. The main growth engines were the investment banking and asset management divisions. Credit quality showed no signs of deterioration with stable nonperforming loans. On the environmental, social, and governance front Credit Agricole became the first European bank to commit to a complete exit of coal financing by 2040. We maintain our EUR 10/share fair value estimate and our no moat rating.

No-moat Credit Agricole reported pretax profits of EUR 712 million for the final quarter of 2020, but this was materially distorted by a EUR 903 million goodwill impairment charge. Excluding this impairment, pretax profit came to EUR 1.6 billion, in line with what the group reported for the fourth quarter of 2019. Revenue growth of 3%, supported by flat cost growth, led to a 9% increase in preprovision profits. The consensus of analysts polled by the company itself expected pretax profit of only EUR 1.1 billion for the quarter. Revenue came in 5% higher than expected, driving a 10% increase in preprovision profits. Loan-loss provisions for the quarter came to EUR 538 million, materially lower than the EUR 827 million provision analysts expected. We maintain our EUR 10 fair value estimate and no-moat rating.

For all intents and purposes, the European Central Bank has extended its shareholder distribution suspension for European banks until September 2021. Supervisors did give a small concession in the form of reduced dividend distributions for 2020, but essentially the suspension remains in place. We think the ECB has struck middle ground in its decision, trying to appease banks and their shareholders as well as securing financial stability in uncertain times. We also believe the distribution limit has been set to such a level that all banks could stomach it. This is important from a supervisory standpoint as it avoids any potential signaling of which bank is currently under higher capital constraints. Because of this signaling effect, we expect banks to bend over backwards to pay the maximum allowed dividends in 2020 if permitted by supervisors. With the exception of the banks we anticipate to be loss-making this year, and therefore not eligible to pay dividends under the new guidance, we estimate that all banks under coverage have the capacity to pay up to the maximum amount allowed. Our fair value estimates and moat ratings across the board are unchanged.

No-moat Credit Agricole reported attributable net income of EUR 977 million for the third quarter of its 2020 fiscal year, 19% lower than what it reported for the third quarter of 2019, however materially ahead of EUR 790 million that the consensus of analysts polled by Credit Agricole itself anticipated for the quarter. Operationally, Credit Agricole had a good quarter, year-on-year revenue growth of 2% and a 1% decline in operating expenses drove an 8% increase in preprovision profits. Healthy preprovision profits were offset by an 81% year-on-year increase in loan-loss provisions to EUR 605 million, which is however, lower than the EUR 842 million provision Credit Agricole made during the second quarter of 2020. A 11% decline in pretax income was amplified by adverse movements in tax charges and minority interests. We maintain our no moat rating and EUR 10 per-share fair value estimate.

European banks have never been this cheap. Ever. Even at their 2008 nadir, investors believed European banks were worth more than they do today. The average multiple of European banks fell by half after the 2008 global financial crisis, which was justified as their profitability was also halved. There is no indication of such a step change in profitability happening now. It seems investors are fretting about the prospect of large-scale asset impairments, which may force banks to once again pass the cap around for a capital injection. We published an Observer, "Impact of Coronavirus on Credit Quality, Capital Adequacy, and Profitability Is Manageable; European Banks Remain Undervalued" on July 6 to explore the valuation, credit quality and capital adequacy of European banks in more detail.