French-based multinational bank Societe Generale (OTCPK:SCGLY) definitely got some parts lopped off during the credit crisis and European recession, but the bank has since proven that reports of its demise (or perpetual irrelevancy) were greatly exaggerated. The company's performance in 2013 was by no means flawless, and the company has much still to do, but patient shareholders have been rewarded with a nearly 70% rise over the past year and a 90% rise over the past two years.
Relative to distressed brethren like Citigroup (NYSE:C), Bank of America (NYSE:BAC), Santander (NYSE:SAN), and HSBC (NYSE:HSBC), Societe Generale has the best two-year performance of the lot, with only Bank of America coming close to challenging SocGen's return. Looking ahead, there is still a credible argument that SocGen can do better and see further re-rating. The company's ROE goal of 10% does not seem out of line and can underpin a $14 fair value, while outperformance in areas like Russia could offer some scope for upside.
It Has Been A Bumpy Road Back
While Societe Generale saw its outperformance vis a vis a consensus expectations slowdown significantly in the third quarter, adjusted or underlying profits were about 30% to 40% above consensus for the fourth quarter. I give a range there instead of a number, as no two analysts seem to agree on exactly how to adjust the reported results of these large banks to account for various litigation reserves, charge-offs/write-offs, and so on.
French retail profits declined about 12% sequentially in the fourth quarter on small declines in lending, while the company's international operations continue to be stressed by weak economies in Russia and Romania. Financial services and core investment banking were both better than expected, and provided the bulk of the upside for the period.
Importantly, SocGen ended the year with a Basel 3 Core Tier 1 ratio of 10%, finally putting it basically into the clear with its capital situation. SocGen was slower in getting there than Citi or Bank of America, and that has kept the company from moving forward as quickly with cash returns to shareholders, but the runway to better cash dividend payouts now looks clearer.
With Room To Improve
SocGen has certainly had its issues, and it shows in the numbers. The company's reported ROE for 2013 was a bit below 4%, while Bank of America was around 4.6%, Santander was 6%, Citi was close to 7%, and HSBC was close to 9%. Likewise, the company has been somewhat hamstrung in cutting costs (closing branches and firing workers is much harder in France), and its expense ratio is the highest of the bunch.
Even so, I would argue SocGen's numbers are not so bad. The bank has considerably less exposure to high-return businesses like investment banking and trading, as HSBC has double the i-banking revenue of SocGen, and Citi and Bank of America have about triple the i-banking revenue. For trading, Bank of America is about five times as large as SocGen, with Citi and HSBC close to three times as large.
I believe there are multiple opportunities for SocGen to improve its results. The company's Russian operations (Rosbank) have been a drag for some time, struggling with single-digit ROEs well below Sberbank, and generating about 16% as much revenue as the French retail operations but less than 10% as much of the pre-tax profit. Restructuring efforts are underway, and management believes that 15% long-term returns are possible, though Russia's current economic situation and the risk of government retaliation against Western interests cannot be ignored.
French retail banking and non-banking operations like financial services also hold the potential for greater contributions down the road. Returns on equity in the mid-to-high teens seem reasonable for the French retail banking operations as Europe recovers, particularly as SocGen has considerable scale in the country and depositors seem less eager to chase higher rates with offshored deposits. On the financial services side, SocGen has been looking to grow operations like auto lending and equipment financing, and these should benefit from a European economic recovery.
The Right Asset Mix For Growth?
The realities of the financial crisis forced a lot of banks into hard decisions. SocGen jettisoned its Greek and Egyptian operations, and has scaled back its risk appetite in areas like prop trading. In that respect, then, SocGen has a few things in common with Citi, Bank of America, Santander, and HSBC - all of which scaled out of non-core markets.
Even so, I wonder about the relative appeal of SocGen's operational base. Bank of America had to scale back its global operations, but still has a banking presence in growing emerging markets like Brazil, Mexico, and Chile, and multiple markets in Asia, Africa, and Eastern Europe. Citi and Santander are even stronger in Latin America, and that is relevant as those markets are generally growing faster and are considerably more profitable than SocGen's Central and Eastern European banking markets.
Relative Growth And Relative Value
Sell-side expectations for returns on tangible equity in 2014 are pretty similar for Citigroup, Bank of America, and Santander, but the valuations are definitely not so similar. SocGen's T/PBV ratio of 0.75x lags the lot, with Citi at 0.85x, Bank of America at 1.2x, HSBC at 1.25x, and Santander at 1.6x. Some of this may well be self-inflicted, as SocGen's goal of 10% ROEs is low compared to most other banks of its size and the market is still imposing a higher implied discount rate/cost of equity for its international operations.
All in all, I still believe the market is missing the boat on SocGen. A long-term ROE of 10% isn't guaranteed, but if SocGen achieves that (and using a slightly lower discount rate to account for the improved capital situation), a fair value of $14 is quite reasonable. That leaves approximately 10% upside for SocGen, and a 0.9x multiple to TBV would support an even higher target above $14.50.
The Bottom Line
The days of finding deeply undervalued bank stocks without too much searching are gone, but I don't think the upside in SocGen has disappeared. Management's modest goals for ROE improvement seem achievable, and the company's capital position creates new options for capital deployment (most likely returning capital to shareholders, but perhaps growth-oriented investments as well). While all of these large banks have an angle (HSBC's global diversification, Santander's exposure to faster-growing Latin American markets, Bank of America's leverage to a U.S. housing recovery, and Citi's global banking and trading operations), I'm content to stick with the self-improvement story that is underway at SocGen.
Disclosure: I am long SCGLY. 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.