Banco Santander: 50%-Plus Upside In 3 Years

Jan.27.14 | About: Banco Santander (SAN)

Rationale

In October 2013, José Antonio Álvarez, Santander's (NYSE:SAN) CFO, made some remarks about the bank's outlook. He focused on the Return on Tangible Equity ROTE, in order to explain the current movement of the bank. Basically, Santander's CFO estimates that the bank currently has a ROTE around 9%.

However, the most interesting fact was the outlook given by Alvarez. He said that Santander should be able to adapt to the new ROTE levels and, in the medium to long term, the bank should be able to improve the ROTE to around 13%. In the long term, during the cycle normalization, Santander should be able to benefit from lower provisions and higher interest rates, which should further elevate the ROTE to around 18% (Source: Santander). This is in accordance with an article that I wrote a couple of weeks ago about Santander.

My goal with this article is to provide my own interpretation of Alvarez's outlook. Therefore, I will define a set of assumptions and then I will build two valuation scenarios: one optimistic and one pessimistic. The optimistic one should represent the scenario where the ROTE estimation works smoothly, while the pessimistic one should represent the case where some of the variables get out of hand. This should provide a simplistic analysis for the upside and downside relation for this particular stock.

Optimistic

  1. The tangible equity will grow moderately in the following years, however, in order to be conservative, I will consider it stable during the following 3 years.
  2. The ROTE will grow from the current level to 16% in 2016.
  3. The number of shares outstanding will stabilize around 11,500 Million shares until 2016.
  4. The valuation multiple will grow to 16, in 2016, justified by the improved profitability.

Pessimistic

  1. I believe that the tangible equity will remain stable during the following 3 years.
  2. The ROTE will grow from the current level to 12% in 2016.
  3. The number of shares outstanding will keep growing, reaching 13,000 Million, in 2016.
  4. The valuation multiple will decrease to 12, in 2016, justified by the lack of improved profitability.

Wrap-up

After looking at these two scenarios, I conclude that there is a good opportunity in Banco Santander stock at the current price of € 6.56. Based on my 3-year estimations, we can see that, in the optimistic scenario, the potential return is superior to 50%. On the other hand, in the case of a bad outcome, the result is a loss around 22.33% (It should be noted that I did not include the dividend returns for the sake of simplicity). Clearly, the results indicate that this stock has more upside than downside.

Disclosure: I am long SAN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.