The Euro crisis hit Spain hard and Spanish bank stocks have understandably suffered. Now that the EU economy appears to have stabilized a bit, you may wonder if this is the right time to buy SAN or other Spanish banks.
The Pain in Spain
Spain followed a story line similar to United States. Cheap credit and easy real estate loans, coupled with a sunny climate led to a boom in North Europeans buying up property in Spain. Many of these mortgages soured and with the housing market in a free fall, the banks ended up with significant amount of bad investments on their books. Bankia needed a bailout and although not all the banks were equally troubled, the low confidence in the banking sector punished all the Spanish bank stocks. Furthermore, tightening regulations meant all the banks had to increase their reserves to cover bad loans, improve liquidity and aggressively take the writedowns and chargeoffs which affected their bottomline.
SAN (Banco Santander) is the largest bank in the Eurozone. Headquartered in Madrid, Spain, the company operates primarily in Spain, the United Kingdom, other European countries, Brazil and other Latin American countries, and the United States. Throughout the crisis, the bank has remained profitable and continued to pay its 0.60 Euros/share dividend. The following chart reflects SAN performance over the last 5 years:
SAN performance is in red and is compared to the S&P 500 index. While long term holders have suffered, investors who bought the stock last year are not complaining. Compare this to the Spanish Government 10 year bond, the benchmark issue (Source: Bloomberg). The yield on this crossed 7% last year that is considered to be unsustainable. Calm has now returned to the market and the yield has been settling down. Both the chart above (SAN stock performance) and the Spanish 10 yr note yields is set for the same 5 yr time scale, so it is easy to see the correlation in the recent years.
Should You Buy SAN Now or Not?
SAN stock price is up 11.66% from the year ago and 81% from the lows it posted in Jul 2012. Still, the stock appears to be cheap. Generally, when an entire economy and its financial institutions have just gone through a wringer, it is not useful to make any projections based on the financials from the recent history. The most we can do is,
- Look at the current valuations based on known assets, and,
- Review the business performance during the crisis to get a sense of how well the company is run. This should give us a good indication of the potential under more normal conditions.
Current Valuations as of Jan 27, 2013
|Stock price||$8.81||Market Cap||$83.65B|
|Dividend Yield||6.90%||Profit Margin||6.72%|
The company has over $479 B in cash with $451 B in total debt. While the earnings in 2012 have declined year over year, it is mainly due to extra provisioning of reserves for non performing loans as mandated by the government. For example, in the first half of 2012, the Net Income went down by 1.797 B Euros to 1.704 B Euros, of which 1.923 B Euros was due to the extra provisioning for the real estate risk. Interest income on the other hand increased by 2.3% in the same period. Total revenue producing assets (loans, credits) increased 7.5% even as the demand for loans and credit products declined in Spain (by 4%) and Portugal (by 7%). The increases came from Latin American, UK and US.
The company has less lending exposure to Spain and Europe today compared to the past. 60% of the loans the company makes is now outside of the Continental Europe, with Spain only accounting for 28%. UK at 35% and Latin America at 19% (Brazil 10%) now providing the much needed geographic diversification and exposure to fast growing emerging markets.
The company has maintained a Euro 0.60/share annual dividend rate for the last 3 years and is likely to keep or grow it in the future. This roughly translates to 6.90% yield on its stock today. If you buy SAN stock for income, you have a choice of taking the dividend as either cash payment or in more shares.
Santander passed the stress test administered to the Spanish banks and now has adequate provisions against risk of bad loans. Going forward, the regulatory impact on the balance sheet and income statement should stop, and as the Eurozone returns to normalcy, the retail banking giant should be able to grow its deposit and lending base. Further growth in emerging economies and geographic diversification reduces the risk in the business and adds to the future growth rate.
At less than the book value and a projected PE ratio below that of its peers, the stock seems to be attractively priced. I would still like to go deeper and review its assets and asset quality, but the stock has me interested enough to add it to my watch list.