Banking and finance stocks were one of the most unpopular and worst performing sectors in 2011 and this is expected to continue through 2012. This poor performance is reflected by the KBW Bank Index, which at the time of writing is 7% down since the start of 2011 and around 55% down since prior to the global financial crisis (GFC). This poor performance is because many European and U.S. banks have been unable to grow revenues and income as they are still grappling with the residual overhang from the GFC and the 2011 eurozone debt crisis. In addition, the new regulatory requirements governing the conduct of banks has stymied many growth opportunities.
Yet, the Latin American banking sector weathered both the GFC and the eurozone debt crisis remarkably well and I believe that as a result it presents investors with a number of investment opportunities. Furthermore, these investment opportunities are enhanced by the stronger economic growth that Latin America has been forecast to experience in 2012, which at 4% is more than double the 1.8% forecast for the U.S. This economic growth is creating growing demand in Latin America for credit and other banking services. One Latin American bank that I believe will be a standout performer in 2012 and constitutes a solid investment opportunity for risk tolerant investors is Banco Santander Brasil (BSBR), a separately listed subsidiary of Spain's Banco Santander (STD). Banco Santander Brasil is well positioned to capitalize on the growth of Brazil's economy and I will explain why.
Banco Santander Brasil is a full service bank offering the full suite of banking and wealth management services. For the fourth quarter 2011 Banco Santander Brasil reported (pdf) a solid 30% increase in revenue to $5 billion, but a marginal 0.1% fall in net income to $968 million. For the same period its balance sheet strengthened with cash rising by 1% to $35.5 billion and total liabilities falling by 5% to $173 billion. However, Banco Santander Brasil reported a solid full year 2011 result with revenue increasing by 16% to $15 billion and net income rising by 5% to $4.2 billion.
In addition to the solid full year 2011 finances, there were also a number of key takeouts from those results that I believe bode exceptionally well for Banco Santander Brasil's future revenue and income growth. These include:
- Net fees growing by 7.4% in 2011, compared to 2010, due to sustained growth in the insurance, savings bonds and credit card businesses.
- Commissions on insurance policies and savings bonds increasing by 28.8%.
- 2011 revenues from credit and debit cards increasing by 33.9% from 2010 levels.
- A solid 20.9% growth in the size of Banco Santander Brasil's credit portfolio in 2011.
Yet despite a solid full year 2011 financial result, Banco Santander Brasil's key performance indicators are not particularly strong and in comparison to its competitors, indicate only moderate growth prospects as the table below shows.
Debt to Equity Ratio
Banco Santander Brasil
Banco Bradesco (BBD)
Itau Unibanco (ITUB)
Bank of America (BAC)
Overall, Banco Santander Brasil's PEG ratio does not bode well for future growth and indicates that the bank's growth prospects are less than Banco Bradesco's, Itau Unibanco's, Bank of America's and Citigroup's five growth prospects.
Its profit margin, while less than its direct competitors in Brazil such as Banco Bradesco and Itau Unibanco, is superior to both Citigroup and Bank of America. On initial appearance I am not particularly impressed with Banco Santander Brasil's return on equity, which while greater than Bank of America's and equal to Citigroup's is substantially lower than Banco Bradesco's and Itau Unibanco's. However, given that Banco Santander Brasil has a substantially lower debt to equity ratio than those banks, this, in my opinion, does not constitute a significant issue as it is generally accepted that the higher a company's degree of leverage the higher its return on equity needs to be to compensate for the additional cost and risk. Finally, Banco Santander Brasil's credit rating while above the minimum investment grade of BBB- is still lower than Banco Bradesco's, Citigroup's and Bank of America's, although it is the same as Itau Unibanco's.
However, I do like Banco Santander Brasil's conservative debt to equity ratio of 0.63, which is unusual for a bank. Typically banks have higher debt to equity ratios as their balance sheets are leveraged due to borrowing funds from wholesale debt markets to fund their lending operations. However, Banco Santander Brasil has a debt to equity ratio of less than one which indicates that it is not heavily reliant upon wholesale funding for loans and would appear to be using its deposit base to fund a large portion of its loan portfolio. This is a less risky and more cost effective option, although it does place a cap on loan portfolio growth. Overall, this bodes well for both income and dividend stability, and is also a good indicator of the lower overall degree of risk an investor takes when investing in Banco Santander Brasil, in comparison to its competitors.
While the performance indicators do not indicate that Banco Santander Brasil is performing particularly strongly, these are not the only basis on which to form a view of whether it constitutes a good investment opportunity. I also believe that by examining a company's forward valuation in comparison to its competitors that an investor gains further insight into a company's investment potential.
With a consensus 2012 EPS of 98 cents and a current trading price of around $10, Banco Santander Brasil has a forward PE of 10, which I believe makes it cheap especially in comparison to its competitors. Banco Bradesco is trading at $18 and the consensus forecast 2012 EPS is $1.74, which gives it a forward PE of 11. The 2012 consensus forecast EPS for Itau Unibanco is $1.98, which at its current trading price of around $20 gives it a forward PE of 10. Citigroup, which is trading at around $37 with 2012 consensus forecast EPS of $4.07, has a forward PE of 9, which does make it look cheaper than Banco Santander Brasil. Finally, Bank of America has consensus forecast 2012 EPS of 68 cents and a trading price of $10, therefore giving it a forward PE of 15, which makes it the most expensive of these banks, but Banco Santander Brasil does appear cheap in comparison to the other banks except for Citigroup.
I quite like Banco Santander Brasil's solid dividend yield of around 5%, which is higher than Bank of America's 0.4%, Banco Bradesco's 0.6%, Itau Unibanco's 0.5% and Citigroup's 0.1%. This solid dividend yield in my opinion makes Banco Santander Brasil a good choice for income seeking investors and with a payout ratio of 46% should give investors a consistent and sustainable income stream. However, when investing in Brazilian companies it is important to remember that in many cases the total dividend yield is made up of two components a dividend payment and a distribution of interest on shareholders' equity (ISE), which is an alternative form of payment to shareholders. Essentially the ISE payments are not guaranteed and may vary from payment to payment and year to year.
I also believe that Banco Santander Brasil is unfairly valued by the market as it has an earnings yield of 12%, which is more than four times the risk free yield. Even after allowing for an additional equity risk premium of 4%, plus a minimum 2% risk premium for investing in a Brazilian company, Banco Santander Brasil is in my opinion undervalued by the market. Accordingly, the stock price should appreciate in value.
Overall, the 2012 outlook for the U.S. banking sector is quite poor, as the sector continues to deal with the fallout from the credit crisis and the European sovereign debt crisis, as well as a softer U.S housing market and a slower than expected U.S economic recovery. All of which is exacerbated by the additional actual and opportunity costs created by the new regulatory environment that has been introduced, which has increased capital constraints and compliance costs. These factors are not having the same impact on the performance of Latin American banks. Therefore, for these reasons the Latin American banking sector is quite appealing as it allows investors to gain banking exposure with superior growth prospects to the U.S while geographically diversifying their portfolio.
However, one looming concern is that Banco Santander Brasil's parent, Banco Santander Spain has been battered by the eurozone debt crisis and Spain's increasingly precarious national debt situation and economic outlook. All of which may have a flow on effect on Banco Santander Brasil. But, Banco Santander Brasil has stated that it will not experience any flow on effects from the problems its parent is experiencing as it has very little exposure to the European banking sector and for all purposes is a separately listed entity that operates on a model of complete independence regarding capital and liquidity. This also means that Banco Santander Brasil will not be funding its Spanish parent or financially bailing it out.
I also quite like Banco Santander Brasil's recent completion of a bond issue in March 2012 that was fully subscribed. This saw the bank raise CHF150 million, giving it additional capital to strengthen its balance sheet and fund further expansion through its growth strategy. The key planks of which are:
- Improving operating efficiency through identifying synergies and implementing improved business practices with a focus on client management, all of which will lead to improved operating margins.
- Expanding its product offering and distribution channels in the commercial banking market through targeted marketing, and leveraging from existing customer relationships.
- Leveraging off and capitalizing on its strong market position in the wholesale business, especially through the relationship it holds with its parent, as Banco Santander provides banking and financial services to a number of multinational corporations.
- Continuing to grow its insurance business by leveraging on its strong branch network and client base to cross sell insurance products thus maximizing revenue per customer. It is important to note that unlike traditional retail banking products, insurance products have a higher margin and are 'stickier' business, thus leading to stronger and more consistent revenue streams.
When reviewing the full year 2011 results, the success of Banco Santander Brasil's growth strategy is already evident with significant growth in its loan book, as well as the revenue derived from insurance policies.
Furthermore, the Brazilian economic outlook bodes well for Banco Santander Brasil's growth; firstly, as Banco Santander Brasil is Brazil's fifth largest bank by total assets and total deposits and it is operating in South America's most populous country, with the continent's largest economy. Secondly, the IMF has forecast 2012 GDP growth for Brazil of 3.6% which is double the 1.8% forecast for the U.S. Thirdly, the Brazilian central bank (Banco Central Do Brasil), as part of the measures being undertaken by the Brazilian government to stimulate economic growth, this month dropped the official interest rate to 9.75%. All of which indicate that Brazil's economy will continue to grow through 2012, obviously giving Banco Santander Brasil the ability to capitalize on its market share.
However, when considering investing in Latin American companies investors must understand that they are accepting a greater degree of risk that does not exist when investing in a U.S company. Much of this additional risk is in the form of country risk, but with regard to Brazil I do not believe that this risk is significantly high, despite some indicators showing otherwise. I have taken this view as Brazil has an S&P BBB international credit rating, which is above the minimum investment grade of BBB-. Furthermore, the international community has expressed a strong degree of confidence in Brazil through awarding it the right to host the 2014 FIFA World Cup and 2016 Olympics. For a more in depth analysis of Brazil's country risk refer to my article 'Vale a Solid Mining Investment for 2012'.
Despite Banco Santander Brasil's disappointing fourth quarter 2011 financial results, I believe that it is a solid value investment, which at its current trading price should accrue in value and deliver solid investor returns in 2012. I have formed this opinion on the basis of its earnings yield which is well in excess of the risk-free rate of return coupled with its strong growth prospects and relatively cheap forward valuation.