The Major Catalyst For Santander That Nobody Is Talking About

Jul.22.14 | About: Banco Santander (SAN)

Summary

Santander has 1/5 of its total profit coming from Brazil, tied for the most from any nation.

The Brazilian economy has been showing sluggish growth recently.

The upcoming presidential election in Brazil provides an interesting opportunity for the economy to be put back on track.

Despite being a Spanish bank, Banco Santander, S.A. (NYSE:SAN) derives only 14% of its attributable profit from its home nation, making Spain the third largest market for SAN in terms of profit. The entire breakdown of attributable profit can be found on the company's most recent Conference Call or in its Investor Presentation for Q1 2014. Santander has been a popular choice for investors looking to capitalize on the European recovery, with shares more than doubling over the last two years. According to Charles Schwab's trading platform Street Smart Edge, SAN's valuation figures are beginning to point to the giant bank reaching into overvalued territory. SAN trades at a P/E of 23.95, a forward P/E of 15.95, and has a price/book ratio of 1.18. There is one major factor that I believe is not accounted for completely in analysts' expectations for Santander's future, and that is the lender's large exposure to Brazil. Brazil is tied with the United Kingdom for the top spot in Santander's profit share, commanding 20% of income. All eyes have been on Brazil over the last month and a half, but not because of its economy. The 2014 World Cup mesmerized the entire world, as it generated record viewership ratings for multiple networks, but now Brazilians are turning their attention to the economy and the upcoming presidential election.

Brazilian Economy

Brazil is one of the least stable economies in the world and has been struggling for the last few years. The recovery effort in Brazil began to gain traction in 2013 and had the country's finance ministry's secretary of economic policy Marcio Holland convinced that 2014 could be the year that Brazil breaks out. Holland believed that his country can thrive on the back of increased domestic consumption spending, infrastructure investments, and record grain output. This vision, at least partially, has not come to fruition to date and many economists have lowered their GDP forecasts for Brazil for all of 2014 and looking forward to 2015. Many are hoping that the jobs created and the infrastructure spending by the government will spur the economy back on track, but some analysts believe it will have little to no effect. Moody's has stated that the World Cup will have a minimal effect on the Brazilian economy as a whole, given the relatively small amount spent when compared to the size of the entire economy. The Brazilian government has spent approximately $11.5 billion in anticipation of the world's largest sporting event. That figure is dwarfed by the $2 trillion that the entire economy is worth. The poor growth in Brazil has proved to be a drag on SAN, especially considering the large presence the bank has there.

Presidential Election

Many investors have called for a regime change in Brazil, as they express their distaste for current president Dilma Rousseff. Some feel that a more pro-business president in the country would help get the economy back on track; Rousseff is up for re-election this October. Despite holding a large lead in early polling surveys, Ms. Rousseff has seen her popularity wane in recent months. I expect her fall in popularity to continue now that the distraction that was the World Cup is over. Investors need to be cognizant of the World Cup's stature in Brazil. 2014 was the first year Brazil hosted the tournament since 1950 and was heavily anticipated since its location was announced back in 2007. After seven years of waiting, Brazilians need something else to consume their attention and the upcoming election will be where their focus will reside. The citizens of Brazil will now be fixated on the candidates, with the sluggish performance of the country's economy at the forefront of their minds. Brazilians are soon going to be demanding that next term's president be one that stimulates the economy and lowers inflation, which is currently hovering around 6%, compared to 2014 GDP growth targets that are now under 1%.

Enter Aécio Neves, a candidate from the PSDB (Brazilian Social Democratic Party) who, if elected, is expected to give the Brazilian stock market and economy a boost. Kenneth Rapoza at Forbes believes that Neves winning the election should increase foreign portfolio investment while not impacting foreign direct investment. Neves also will decrease public spending in an attempt to reduce inflation, according to his interview with Globo News. This effort may be a critical talking point in his campaign. with Brazilian citizens still outraged at the cash disbursements made by the Government to fund the World Cup. If Neves is elected and his spending cuts are implemented, there will be an immediate positive reaction in the Brazilian stock market from both domestic and foreign investors; the Bovespa Stock Index has risen 25% since initial reports of Rousseff's support base wavering towards Neves. A win for the PSDB would bring much-needed economic optimism to Brazil and will spur growth, both of which are good things for Santander.

Hedge Fund Manager Endorsement

I am not the only one who believes that Brazil's economy is a place for potential profit. At CNBC's Delivering Alpha Conference, Michael Novogratz of Fortress Investment Group explained some of his major investing ideas for the upcoming year. Rather than focusing on individual sectors or stocks, Novogratz prefers to examine countries where the economic situation makes investment attractive. Brazil was one of Novogratz's top choices. While Novogratz's bullishness stems around Brazilian equities, it is the underlying reason for investment which I believe makes Brazil and excellent potential profit driver for Santander as well.

Santander In Brazil

This past quarter Santander reported that costs in its Brazil operations rose 2.5%, or a real decrease of 3.4% when inflation is accounted for. Management foresees continued expense reduction in Brazil for the rest of the year. The bank also managed to lower provisions in the struggling country, something that is not easy to do during periods of financial uncertainty. Speaking to the economic environment in Brazil, CEO Javier Marin Romano acknowledged that near-term headwinds exist in the country on the conference call, but that he remains "optimistic" about Santander Brazil's long term prospects. CFO Jose Antonio Alvarez has called Brazil a country with "underlying strength" and clarified that the bank is currently focusing on improving productivity and commercial efficiency. Instead of merely weathering the storm, SAN is taking strides to position itself to profit from Brazil's recovery by reducing costs and maximizing efficiency. This will allow the bank to squeeze the most amount of profit possible out of operations in Brazil, something that will be a major profit driver in the future.

If the increasingly likely scenario of Aécio Neves taking over the presidency occurs, the economy as a whole will thrive and give a crucial boost to the stock market. Investing in Brazil is a risky proposition, but one with tremendous upside. Equally as important as the potential recovery in Brazil is Santander's foresight in the country. Management sees the opportunity that will arise if the economy gets back on track and is doing everything it can to take full advantage of it. Shares of Santander are an excellent way to benefit from the potential rebound of Brazilian GDP growth without having to be invested in a company whose stock is undiversified and much more dependent upon Brazil for profit.

Disclosure: The author is long SAN. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.