My broad thesis on Deutsche Bank (DBK) is that it is a strong restructuring play and the crucial consideration is its revenue evolution: CEO Cryan knows what he can do with costs and long as his revenue base holds.
Whether revenue does hold going forward is a real question given the travails of the bank opposite the DOJ that consumed the fourth quarter of last year. Don't forget, there were some very alarmist statements around the September lows. And, with 4Q results today, we see that there is some evidence of lower client activity in DBK's markets division. That's a disappointment, if not a total surprise, for me. However, I think the overall thesis remains intact.
Revenue for the fourth quarter was 9% shy of expectations at €6.4bn vs. €7bn consensus. Of the €0.6bn miss, €0.4bn came from global markets, where revenues excluding CVA/DVA items were €1.7bn vs. €2.1bn expected. On A YoY basis, this division's revenues were 14% lower for the quarter, with DBK explaining the dip with reference to client activity in the form of "DB-specific concerns" and the impact of strategy 2020."
Strategy 2020 is a mostly cost cutting program and I think the DB specific concerns will calm down now the DoJ is settled, since it was this that most threatened the bank's capital adequacy. While I remain optimistic about Strategy 2020, the risk of that program has to be an impact on the business perimeter as DBK rationalizes its cost base. Two points prevent me reaching too gloomy a conclusion from this quarter though. First, this quarter doesn't change my view that there is little DBK sells that requires an underlying cost/income ratio either side of 80% so the idea that it can reduce its costs to the 70% of income long term target is plausible. Second, the bank expects some growth in risk weighted assets in 2017, which will support revenue going forward and has indicated that January was strong across all businesses. DBK will enjoy an improved banking environment at least as much as peers!
Here is the key P&L data from the quarter as provided in DBK's results presentation.
The "adjusted" pre-tax earnings number for 2016 was $5.3bn, with a truly abysmal cost/income ratio of 82%. DBK has reiterated its expectation that its 2018 target for adjusted costs, which is €22bn, remains "expected to be achieved". If DBK can hold a €29-30bn revenue level, then a €22bn cost base by 2018 will give us underlying pre-tax of €7-8bn, and the market will price off this core number if DBK's significant expenses in restructuring, litigation and goodwill impairments start heading in the right direction.
In my recent article on DBK, one commentator pointed out that my broad brush "back of the envelope" underling pre-tax number for 2016 was too high given 4Q is usually weak. Kudos. We got €5.2bn not €5.6bn. However, the price/core earnings in DBK is so low that misses of 7% don't undermine the case. At a market cap of é25bn, the deep value remains if you think DBK can approach the underlying numbers that are in the frame for 2018. If you are minded this way, then do run lower revenue numbers to stress test your valuation as 2016 benefited by around €1bn from disposal proceeds from Hua Xia and Visa. It takes a lot to undermine the core value here, despite the noise.
A bright spot for the quarter was the CET1 ratio which improved to 11.9% or 11.7% adjusted for 4Q seasonality. The target is 12.5% for 2018 and DBK will attempt to sell Postbank starting this spring as part of the plan.
It is always easier to talk about a long recommendation after a strong quarter than the one DB has just given us. At the time of writing, the stock is down 2.9% having hit 5.5% down in the first hour post the results release. Assuming the analyst call maintains the fundamental outlook, DBK remains a buy for the value oriented member of the bank cognoscenti.
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.