Poor Risk / Reward For Bradesco And Bilbao

Includes: BBD, BBVA
by: Takeover Analyst

My outlook on American, and even British, financials is nearly always positive due to a faith in the resiliency of the developed economy and historically-leading fundamentals domestically. With emerging market growth, investors naturally should be attracted to international banks that will fuel a burgeoning consumer population. My advice is to support the nation with the comparative advantage and thus steer away from an investment in Banco Bradesco (NYSE:BBD) and Banco Bilbao (NYSE:BBVA).

From a multiples perspective, both firms appear cheap. Bradesco trades at a respective 6.2x and 8.4x past and forward earnings while offering a dividend yield of 0.7%. Bilbao may offer a dividend yield of 7.7%, but I question its sustainability due to instability and a EBA shortfall of more than 7B euros. The Spanish bank trades at a respective 6.6x and 7.9x past and forward earnings. Overall, the Street and I both have preference for Bradesco due to its greater product diversity (insurance services and banking services), expanding operational volumes, and a greater confidence in the Brazilian economy.

At the third quarter earnings call, Bradesco's Head of Investor Relations, noted:

"Our adjusted net income for the first nine months of 2010, which totaled R$7,120 million, around 24% higher than in the same period last year. Total assets amounted to R$612 billion, a 26% improvement over September 2009…

[O]ur funds under management… totaled R$838 billion, showing an evolution of 24% in that one year period. I’d also like to call your attention to our delinquency ratio, which fell substantially in compares to 2009 and to our coverage ratios, which have meet both the unimportant evolutions".

Book net income showed an annualized retune of more than 24% while return on average equity exceeded 22%. NPL ratios will remain roughly flat until at least the end of the year. In addition, unemployment and interest rates are decreasing at the same time that a middle class is emerging to fuel demand. It follows that a more consumeristic culture will purchase more goods, which will in turn buoy up the insurance market. Accordingly, Bradesco is in a good position to capitalize on this upside.

Consensus estimates for Bradesco's EPS are that it will grow by 16.9% to $1.73 in 2011 and then by around 10.5% in both of the following two years. Assuming the multiple expands to 9x - plausible due to economic growth - and a conservative 2012 EPS of $1.86, the stock is roughly trading at fair value. If the multiple were to just hold constant and 2012 EPS turns out to be just 5.8% below the consensus at $1.80, the stock would theoretically have 32% downside. Accordingly, I believe that the firm has poor risk/reward and do not agree with the "buy" rating on the Street.

Bilbao, on the other hand, will likely benefit from the parliamentary victory of the center-right Partido Popular. They are likely to present solutions to the banking mess that are not less onerous than some expected, while still a step forward in bringing wholesale funding costs down. By its own devices, Bilbao is offering a 3.5B Euro mandatory convertible note that will pay a rate of 6.5% on preferred shares to close the EBA gap and improve liquidity. On a more cynical note, this may signal that the firm is struggling to reach the 9% CT1 target.

Consensus estimates for the Spanish bank's EPS are that it will decline by 36.3% and 2.9% more in the following year. Analysts currently rate shares of Bilbao a "sell".

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.