Valuentum Exclusive Analysis for the Discerning Investor

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When one looks at individual bank interests and also the national champion nature of many banks that are closely tied to their home countries, it becomes difficult to picture how the overtraded European banking landscape will resolve itself. One scenario is perhaps by smaller banks coming together, though that might not really move the needle that much. We generally dislike the banking industry due to the arbitrary nature of its cash flows, weak economic returns, and highly-regulated nature, and we think Unicredit may be one to avoid, in particular.

By Matthew Warren

Unicredit (UNCRY) put up another measly quarter, results released August 6, this time with small positive underlying net profits of EUR 0.5 billion. Revenues were down 7.7% compared to last year’s second quarter and underlying net profit was down a whopping 48.7%. As one can see in the upcoming graphic down below, underlying return on tangible equity (RoTE) was a meager 4.1% in the quarter, well below the bank’s cost of capital.

Image Shown: Summary of Unicredit’s 2Q2020 Results: Image Source: Unicredit 2Q2020 Earnings Presentation

Not only is Unicredit struggling as a group, there are few highlights to speak of. As one can see in the next graphic down below, Central and Eastern Europe (CEE) was the only segment that came close to generating returns at the cost of capital. The bank is also struggling mightily in its home market of Italy (EWI), a country that has been ravaged by COVID-19. We have high hopes for better days ahead when one of the many vaccine “shots on goal” eventually comes through, however.

Image Shown: Segment Contribution of Unicredit’s 2Q2020 Results. Image Source: Unicredit 2Q2020 Earnings Presentation

Sadly, the bank’s goals, as described by CEO Jean-Pierre Mustier in the quote below from the second-quarter earnings conference call, for return on tangible equity for 2021 of 6%-7% are also quite modest indeed:

We confirm our underlying net income target for 2021 of €3 billion to €3.5 billion, which is equating to our RoTE of 6% to 7%. And as already said, we will reinstate our capital distribution plan for 2020 and onward subject to the ECB recommendation being extended targeting a distribution of 50% of underlying net profit.

This leaves investors counting on better macroeconomic days ahead to drive better returns at the bank, but returns may continue to be weak relative to other more attractive banks, and especially relative to other capital-light industries and high-RONIC-generating powerhouses held within the newsletter portfolios. One must also hope the bank doesn’t end up with another portfolio of run-off assets like the ones that it is currently working down.

As to the potential for mergers & acquisitions in European banking, Unicredit’s CEO was quite clear on the call that they are not interested. They want to increase their 10-11% Italian banking share via organic growth and want to shrink employees and branches rather than adding to them via M&A.

Concluding Thoughts

When one looks at individual bank interests and also the national champion nature of many banks that are closely tied to their home countries, it becomes difficult to picture how the overtraded European banking landscape will resolve itself. One scenario is perhaps by smaller banks coming together, though that might not really move the needle that much. We generally dislike the banking industry due to the arbitrary nature of its cash flows, weak economic returns, and highly-regulated nature, and we think Unicredit may be one to avoid, in particular.

Be careful investing in banks!

View our latest video on how banks/financials performed during the COVID-19 crisis here.

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Related: SAN, UNCFF, BNPQF, IITOF, DB, ING, CRARF, SCGLF, BBVA, CRZBF, BCS, BKZHY, LYG, EUFN, EWI, XLF

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Matthew Warren does not own any of the securities mentioned. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.