Deutsche Bank: A Trading Opportunity Ahead Of Q2 Results

| About: Deutsche Bank (DB)

Summary

The main story of U.S. banks’ Q2 earnings season was the strong FICC revenues.

Deutsche Bank is the main beneficiary of better FICC revenue environment.

We think there is an attractive trading opportunity ahead of Deutsche Bank’s Q2 results (due 27 July).

U.S. banks' Q2 earnings were above consensus estimates, thanks to strong FICC (Fixed-Income, Commodities and Currency) results.

Source: Company data

Global capital market revenues dropped 22% y/y and totaled $24bn in 1Q16 - the lowest 1Q result since the 2008-2009 financial crisis. However, capital market conditions have improved from the first quarter, with the FICC segment being a particular strength. In addition, market volatility/activity levels around the June Fed meeting and the Brexit vote were a tailwind for trading gains.

Source: Dealogic, UBS Research

U.S. banks' results is a good read-across for Deutsche Bank (NYSE:DB). The company is traditionally thought of as a classic play on FICC, given its significant exposure to the segment.

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Source: Bloomberg, Renaissance Research

DCM (Debt Capital Markets) division should also support DB earnings. According to Dealogic, debt underwriting fees increased significantly from 1Q16 lows (up 54% q/q).

Source: JPMorgan Research

The consensus expectations are low. In our view, the market is overly pessimistic, expecting total revenues to increase by 3% q/q in 2Q16. Hence, we think there is an attractive trading opportunity and we would recommend buying futures contracts or call options on Deutsche Bank ahead of the Q2 print.

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Source: Bloomberg

Deutsche Bank is a trade not an investment

Deutsche Bank should get a decent boost from the results, in our view. Having said that, it is a trade, not an investment. We are still negative on DB as its earnings will be under pressure from a zero interest rate environment, challenging capital markets conditions, structural industry issues and numerous company-specific tail risks (capital woes, litigation, weak cost control etc).

Deutsche Bank trades at a forward P/B of 0.29x. While the stock looks optically cheap, we believe the valuation provides very limited support as DB's profitability is weak (a return on equity of less than 4%, based on 2017E consensus numbers), while the implied cost of equity is close to the long-term average. UniCredit (OTCPK:UNCFF) (OTC:UNCFY) share price performance is a brutal lesson for those, who go bottom-fishing in DB. The chart below shows that UniCredit is trading at a huge discount to the sector's regression line, despite a return on equity of 5-6%. This valuation suggests that the market is pricing in a capital call at UniCredit. By contrast, DB looks fairly valued, trading in line with valuations of comparable peers. Hence, should the market start pricing in a capital raise at DB, the stock will fall further. We think the results should provide an excellent selling opportunity for those who are still long Deutsche Bank.

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Source: Bloomberg, Renaissance Research

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

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.

Additional disclosure: I am/we are long call options on Deutsche Bank