Latin America has escaped many of the effects of the financial crises that have shaken the world's modern economies to the core. In addition, the region's banks have weathered these crises particularly well, unlike their European and U.S. counterparts. This has allowed these banks, in the absence of serious competition from international competitors such as Citigroup (C), Bank of America (BAC) or JPMorgan (JPM), to consolidate their market share, grow revenue and maximize margins. This growth is further enhanced by the region's burgeoning middle-class that is driving further domestic consumption. A standout performer among Latin American banks and one that I believe will deliver solid investor value is Banco de Chile (BCH) and in this article I will explain why.
Banco de Chile is the second-largest bank in Chile by assets, after Banco Santander Chile (BSAC), and is the largest bank by total loans under management. It is a full service bank providing the full suite of banking products in Chile and the U.S. For fourth-quarter 2011, the bank reported a 2% increase in revenue to $555 million and a 1% rise in net income to $205.5 million. For the same period its balance sheet strengthened with cash and cash equivalents rising by 6.6% to $1.98 billion and long-term debt fell by 38% to $5.4 billion. For the full year 2011 Banco de Chile delivered a record result, because despite revenue rising by a modest 14% to $2.3 billion, net income rose by 13% to a record $885 million.
In conjunction with the record full-year result for 2011, Banco de Chile delivered some solid outcomes, which I believe augur well for future net income growth, including:
- Net interest income grew by 18.8%.
- Total loans increased by 20.1% making Banco de Chile the leading lender in Chile.
- Loan loss provisions fell considerably 40.2% to $240 million.
- Banco de Chile ending 2011 as Chile's most profitable bank as judged by a return on average equity (ROAE) of 23.7%, which is higher than the 2011 industry average of 17.7%.
Banco de Chile also has some particularly strong performance indicators, especially in comparison with its competitors, as the table below shows.
Debt to Equity Ratio
Banco de Chile
Banco Santander Chile
With a PEG of 1 Banco de Chile's price, accounting for its future earnings growth, is cheaper than its peers except Corpbanca. It has a solid profit margin, which is similar to its Chilean competitors and substantially higher than both U.S-based JPMorgan (JPM) and Citigroup (C). I also like Banco de Chile's return on equity, which is the best of the Chilean banks and superior to JPMorgan's and Citigroup's, indicating that it is well managed. Furthermore, its strong return on equity coupled with a double-digit profit margin bodes exceptionally well for the bank's future earnings growth.
While Banco de Chile has a high debt-to-equity ratio of 2.5, it is equal to or lower than its competitors. Such a high debt-to-equity ratio indicates that Banco de Chile is reliant upon using wholesale debt to fund its lending operations. This means it is exposed to movements in short-term interest rates that can have a direct impact on its bottom line. However, unlike its competitors it is delivering a strong return on equity as expected when a company's operations are highly leveraged.
Furthermore, Banco de Chile's Standard and Poor's credit rating of A is well above the minimum investment grade of BBB- and equal to Banco Santander Chile's. It is also superior to both Corpbanca's and Citigroup's, although lower than JPMorgan's. During 2011 Standard and Poor's lowered Banco de Chile's credit rating from A+ to A because of a change in methodology, rather than a change in the bank's financial position. A Standard and Poor's credit rating of A denotes that the bank has been judged to have a strong capacity to meet its financial commitments, but is somewhat susceptible to adverse economic conditions and changes in circumstances.
While the performance indicators show that Banco de Chile is performing strongly in comparison with competitors, these are not the only basis on which to determine whether it is a worthwhile investment. I also recommend examining the bank's forward valuation in comparison with its competitors to see whether it is appropriately priced.
With a 2012 consensus EPS of $6.34 and a current trading price of around $93, Banco de Chile has a forward PE of 15, which does make the company appear expensive in comparison with competitors. Its main Chilean competitor, Banco Santander Chile is trading at $84 and with a 2012 consensus forecast EPS of $6.39, has a forward PE of 13. The other main Chilean bank Corpbanca has a 2012 consensus EPS of $1.85, which at its current trading price of around $20 gives it a forward PE of 11. On the basis of this forward valuation it makes it the cheapest of the three Chilean banks reviewed.
Based on its forward valuation Banco de Chile also appears expensive in comparison with U.S.-based JPMorgan and Citigroup. JPMorgan has a 2012 consensus forecast EPS of $4.95 and with a trading price of around $43 has a forward PE of 9. Citigroup, which is trading at around $35 with a 2012 consensus forecast EPS of $4.16, has a forward PE of 8.
Banco de Chile pays a credible dividend yield of 4% with a payout ratio of 69%. Furthermore, the dividend yield for U.S or foreign investors is reduced by Chilean withholding tax of 35% that is levied on dividend payments to foreigners. Therefore, post-tax the dividend yield is reduced to around 2.6%. There is however, on distribution a 17% tax credit for "first category tax" paid by the company, which may be credited against taxes paid on dividends.
However, Banco de Chile's growth prospects also depend on whether Chile's economy grows convincingly during 2012, especially as the overall global economic outlook at this time is negative. Chile's economy is recognized internationally as one of the most stable, open and competitive in Latin America, with a significant portion of economic growth dependent upon the mining and exportation of raw materials, notably copper. Even so with a growing Chilean middle-class domestic consumption is increasingly becoming a driver of economic growth. While the reliance upon raw materials is of some concern due to the predicted slowdown of the Chinese economy, Chile still has a forecast GDP growth rate of 4.7% (pdf), which is triple the U.S forecast of 1.8% (pdf).
Banco Central de Chile lowered the official interest rate by 25 basis points to 5%, in January 2012, which was the first rate cut seen since July 2009. This rate should help to drive increased domestic economic activity through 2012, obviously assisting Banco de Chile to grow its market share and revenue. In addition, there are a number of economic indicators that signal the Chilean economy is performing well including:
- Since the start of 2012 both business and consumer confidence in Chile has improved, with consumer and business confidence indicators showing a more optimistic outlook.
- Unemployment decreased by 20 basis point in March 2012 to 6.4%.
Accordingly as the economy continues to grow, Banco de Chile with the largest market share in lending, is well positioned to capitalize on this growth and increase its market share and revenue.
Another key consideration when investing in a foreign company is the degree of country risk the company is exposed to. I consider Chile to have the lowest level of country risk of any Latin American country, as I will explain. Firstly, when considering the degree of corruption in Chile, the outlook is quite favorable with Transparency International's Corruption Perception Index for 2011 rating Chile as 22nd out of 184 countries. For 2011 New Zealand, was rated as the least corrupt and Somalia, along with North Korea, as the most corrupt. In comparison with Chile's position, Brazil was rated as 73rd, Argentina as 100th and the U.S came in marginally higher than Chile at 24th. Secondly, from an overall qualitative assessment of country risk, in January 2012 the OECD rated Chile as a 2 on a scale of 0 to 7, where 0 is the least risky and 7 the most. This is the lowest country risk rating awarded by the OECD for a Latin American country.
Finally, Chile has a Standard and Poor's credit risk rating of A+, which is the highest credit rating awarded to any Latin American country. During 2012 Standard and Poor's hinted that Chile is on the road for a AA rating due to the increasing maturity of its economy and ongoing strong fiscal policy. In comparison, other Latin American countries such as Mexico, and Brazil, are rated BBB, while Argentina, has a credit rating of B, which is lower than investment grade. Based on all of these measures it is my opinion that Chile has little to any significant country risk.
For all of the reasons discussed, I believe that Banco de Chile represents a solid investment opportunity for investors who are seeking exposure to the banking sector but are concerned by the investment risk associated with European and U.S banks. The key reasons for forming this view are firstly, it has the highest ROAE ratio of any Chilean bank at 23.7%, indicating that it is the most profitable Chilean bank. Secondly, it has a credible efficiency ratio of 50.2%, which is lower than the U.S. 2011 banking industry aggregate efficiency ratio of 68%, and indicates that the bank is generating $2 for every dollar spent. Thirdly, the bank has a high-quality loan portfolio with comparatively low credit risk as evidenced by a non-performing loan (NPL) ratio of 2.88%, which is lower than Banco Santander's (STD) 3.89% and Banco Santander Chile's 3%. Finally, it has lowered its loan-loss provisions by almost half since December 2010, leaving it with a very respectable loan-loss ratio of 0.79%.