Banco Santander: A Contrarian European Bank Pick

| About: Banco Santander (SAN)
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Well, if you don't have enough excitement watching the markets these days then you should take up skydiving or stock car racing for a hobby. The threat of Greece melting down and taking the rest of Europe with it had the market on edge for weeks. When that was combined with some crazy trading error that sent the Dow down 1,000 points within 15 minutes on May 6, it was enough to shake the confidence of virtually any sane person. As in the movie Terminator 3, we are witnessing the rise of the machines. In only five years, total market volume generated by high frequency traders running computer algorithms has moved from 20% to over 70% of all trades.

The question now is does this current crisis pass or is have we seen early warnings similar to those prior to the subprime meltdown? People who ignored those were punished unmercifully when global stock markets collapsed in the fall of 2008. Some readers may recall that many economists and most pundits were saying that the subprime mess was only a small part of the overall financial system and could be easily contained.

In fact, Fed chairman Ben Bernanke and former chairman Alan Greenspan both said as much during their various testimonies to Congress. In a recent New York Times article, Byron Wien, a prominent Wall Street strategist who is vice-chairman of Blackstone Advisory Partners, was quoted, hopefully not prophetically, as saying: "Greece may just be an early warning signal."

He added ominously: "The U.S. is a long way from being where Greece is, but the developed world has been living beyond its means and is now being called to account."

Last weekend, the finance ministers of Europe put into place a massive bailout fund worth almost a trillion dollars - a figure that simply numbs the mind! Their aim was to reassure the markets that not only Greece would be defended but also Spain, Portugal, and any other indigent eurozone country. Stock markets initially responded positively, although by the end of the week the enthusiasm had evaporated. Nervousness about Europe persists and the last thing we need is another global credit crunch just as we are beginning to pull out of one of the worst financial disruptions since the Great Depression.

The events of last two years have shown us how interdependent the world's economies have become. The whole notion that Europe can fall but we will be fine because China will bail us out just doesn't hold up any longer. Banks in the United States have $3.6 trillion in exposure to the troubled European countries so we better hope that the new European bailout plan will succeed. The U.S. is certainly no position to help given the size of the deficit that Congress and the President will have to manage down over the next few years.

So given all this uncertainty, what's an investor do? Well, invest in Europe of course! (Remember, I tend to be a contrarian.) There are some great bargains available which a few years from now may look as cheap as Canadian bank stocks were back in the winter of 2009.

I have two stocks to recommend this month, both based in Spain. One is a new pick: Banco Santander SA (NYSE: STD). The other is an old favourite, Telefonica SA (NYSE: TEF) which you find in my updates report. Admittedly, both these picks are higher risk and are contrarian in nature so they are not for the more conservative readers of this newsletter. However, both are substantial companies and, given how beaten-down their shares are, they offer courageous investors both high risk and the possibility of high reward.

The Santander Group (NYSE: STD)

The Santander Group is the fourth-largest bank in the world by profits and eighth by stock market capitalization. Although headquartered in Spain, this company is well diversified with significant operations in nine markets including Germany, Brazil, Mexico, the U.K., Chile, Argentina, and the U.S.

The bank has an amazing 91 million customers served by 13,660 branches worldwide, the largest branch network in international banking. In 2009, it was named Global Bank of the Year by the prestigious magazine The Banker.

In making the announcement, editor Brian Caplen said:

Without doubt, the international bank that has come through the crisis the best - and taken advantage of the opportunities that have arisen from it - is Santander. The bank has managed to come up with a winning formula that combines an aggressive sales strategy with sold risk management and tight cost control. In essence, it is a very basic approach to banking but, as has been shown from the crisis, many banks have been unable to emulate it.

The company has consistently expanded through acquisition. It established a strong presence in the U.K. with the takeover of Abbey National for £8.5 billion in 2004 and added to its presence in that country by purchasing Alliance & Leicester for £1.3 billion in 2008. In 2005, Santander took a 19.8% stake in Sovereign Bancorp, the 18th biggest U.S. bank at the time.

In 2009, the company reported net ordinary profits of more than €8.9 billion, 1% better than the previous year, and distributed more than €4.9 billion in dividends to shareholders. With these figures, the Group achieved the target set at the annual general meeting on June 19, 2009 to maintain its profits and the dividend payout.

For the first quarter of this year, the bank earned more than €2.2 billion, up 6% from the same period last year. Revenue grew by 11% year-over-year. Brazil contributed 21% of the Group's profit with a record €603 million in three months, an increase of 38% from a year ago. I want to draw special attention to this because it is the bank's strong presence in Brazil, one of the world's fastest-growing economies, that makes it especially attractive.

Provisions for bad loans during the quarter amounted to €2.4 billion. That was up 10% from last year but the good news is that the pace is slowing dramatically. In 2009, bad loan provisions increased 44% in the full year with growth exceeding 60% in certain quarters. So while the situation is not ideal, there is definite improvement.

In announcing the results, bank chairman Emilio Botín said:

Santander is demonstrating the benefits of being a diversified bank, both in terms of geography and business lines. Despite reduced economic growth, we have maintained our ability to generate recurrent profit and have improved our liquidity, efficiency and solvency.

The share price came under extreme pressure during the worst of the Greek crisis, trading as low as US$9.17 on May 6 (it was trading in the US $18 range as recently as December). The stock rallied strongly after the European ministers announced the big plan to keep the euro in business but it is still down more than 40% from its 52-week high, closing on Friday at US$10.44 after giving back US82c on the day.

Based on the current price, the posted yield is 11.2% however keep in mind that like many European companies the dividend is set annually based on the previous year's results. However, the strong first quarter makes it likely the company will be able to sustain the payout going forward.

It seems to me that most of the risk has been built into the stock and the opportunity for upside is huge. Given the high dividend payout, you can afford to be patient with this one.

Action now: Buy with a target of US $18. The shares trade on the New York Stock Exchange as an ADR so any broker can acquire them for you

Disclosure: Author holds a long position in STD