Following several years of restructuring, KBC Group (OTCPK:KBCSY) has recently announced its dividend related to 2016 earnings. As I've discussed in my previous analysis, market expectations were that KBC would become a high-dividend yield stock and the bank has delivered. Based on the recent announcement of its total dividend, KBC now offers an attractive dividend yield of 4.7%. Given its good fundamentals and strong capitalization, KBC can easily increase its dividend payout ratio in the next few years, making its dividend growth prospects quite good.
Business and Financial Overview
KBC is a retail-focused bank based in Belgium operating under a bancassurance business model, which means that has both banking and insurance operations as its core businesses. This enables it to cross-sell more products and services to its customers. It has a market capitalization of about $26 billion and trades in the U.S. on the over-the-counter [OTC] market.
KBC has a strong presence in its profitable domestic market, but has also some exposure to growth markets in Eastern Europe. Its retail banking activities account for about 85% of its net profit, while the remaining comes from insurance. Like many of its peers, the bank suffered during the global financial crisis of 2008-09 and received State capital, which was fully repaid at the end of 2015. Therefore, the bank is now in a position to focus on growth and to provide an attractive shareholder remuneration policy.
Reflecting its new focus, the bank has recently announced the acquisition of National Bank of Greece (OTCPK:NBGIF) Bulgarian unit for $642 million, strengthening KBC's position in Bulgaria. KBC's strategy is to grow in its current geographic footprint and further acquisitions may be considered in the future to increase its market-share. Its goal is to be among the top 3 players in core countries, thus it may make acquisitions in countries like Slovakia or Hungary in the next few years.
One of KBC's main competitive advantages is its exposure to two concentrated banking markets with good profitability levels, namely Belgium and Czech Republic, enabling it to have above-average profitability. After several years of restructuring and relatively weak results, in the past couple of years the bank has returned to report strong profits. Its return-on-equity [ROE], a key measure of bank profitability, was 18% in the last year. This is among the best profitability levels in the European banking sector and seems to be sustainable over the long-term due to KBC's attractive risk profile.
More recently, KBC delivered positive 2016 financial results, supported by a good performance of the bank-insurance businesses in its key markets. Its revenues have been relatively stable, a good outcome considering the current low interest rate environment existent in Europe. KBC's revenues were supported by increasing customer loan volumes and higher fees and commissions. Its net interest margin [NIM] has stabilized over the past few quarters at about 1.90% and is expected to remain at these levels if interest rates don't change much.
The bank was able to keep costs under control despite rising loan volumes, leading to an improved efficiency ratio of 57% in 2016. Its costs were down due to lower bank taxes, while operating costs remained under control. Nevertheless, the bank still has further efficiency gains to explore, given that the most efficient European banks have efficiency ratios of about 45%. This can be a supportive factor for KBC's earnings growth in the coming years, taking into account that revenues should have limited growth prospects and credit quality is showing the best metrics in years.
Indeed, one important factor for earnings growth in the past few years has been better credit quality, leading to lower impairments and provisions. This is reflected in its lower cost of risk [CoR] ratio compared to a few years ago. KBC's CoR was only 9 basis points (bps) in 2016, a new record low for the bank and much lower than its peak of 121 bps reported in 2013. Going forward, the bank's CoR should remain at historically low levels, unless the macroeconomic situation in its core markets changes substantially.
Given KBC's good operating environment its net income, adjusted for one-off items in the previous year, increased by 9% to $2.5 billion in 2016. In the next few quarters, KBC expects to maintain its good operating performance, supported by sustained economic growth in Europe and improved results from smaller units, like Ireland or Bulgaria.
Capital & Dividends
One of the main positive factors of KBC is its strong capitalization. At the end of 2016, its fully loaded core equity tier one (FL CET1) ratio was 15.8%, being among the best capitalized banks in Europe. Its fully loaded leverage ratio was 6.1%, also showing its superior capitalization compared to most European banks. Additionally, in the past few quarters the bank has been able to increase organically its capital ratios, thus KBC's capitalization should continue to improve in the next few quarters due to its good operating prospects.
KBC's strong capitalization is a factor that puts it on par with the Nordic banks, such as Nordea (OTCPK:NRBAY) or SHB (OTCPK:SVNLY), which are known for its good credit quality and high capital ratios which lead to attractive shareholder remunerations. KBC has recently resumed dividend payments following its state aid ban and its dividend growth prospects are quite good.
KBC reintroduced payments in 2016 with an interim dividend of €1 ($1.05) per share, which was paid in last November. More recently, KBC announced that on top of this interim dividend, it will pay a final dividend of €1.80 ($1.89) per share in the next few months. This means that its total dividend related to 2016 earnings is €2.80 ($2.94) per share. At its current share price, KBC offers a dividend yield of about 4.7%. Investors should note that the Belgium dividend withholding tax is 30%, reducing a little bit the income appeal.
KBC's dividend payout ratio was set at 50% of its net earnings, including dividends and Additional-Tier 1 coupons, and its guidance is quite cautious, saying that it want to maintain this policy in the next few years. However, taking into account its excess capital position and organic capital generation ability, this seems too much conservative and may be increased in the near future. Given its profile, it may easily increase its dividend payout ratio to levels more in-line with its Nordic peers, which on average distribute about 70% of earnings to shareholders.
However, KBC's management is being quite conservative due to some uncertainties that may eat away some of its excess capital position. Namely, Basel IV and the possible introduction of risk-weighted assets (RWA) floors would negatively affect its capital ratios. The impact is still uncertain and KBC is building an excess capital position, compared to its own target of FL CET1 ratio of about 11%. This means that KBC has plenty of room to increase its dividend without being too much aggressive. Indeed, according to analysts' estimates, its dividend payout ratio should increase to around 60% in the next three years, but this still seems conservative considering KBC's strong fundamentals and dividend growth prospects can surprise on the upside.
KBC is one of the best European banks right now, offering strong fundamentals and good dividend growth prospects making it quite attractive to income investors. It offers a dividend yield of 4.7%, which has good growth prospects. The bank has delivered on dividend expectations and its guidance for the next few years seems to be too much conservative, leaving some room for upside surprise compared to current expectations. Its current valuation of 1.56x book value is not particularly cheap, but it is more than justified by its quality business and good dividend growth prospects.
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