FinecoBank: An Underfollowed Gem Within The European Banking Sector

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About: Finecobank Banca Fineco SPA ADR (FNBKY), Includes: AZIHY, ISNPY, UNCRY
by: Labutes IR
Summary

FinecoBank is an Italian bank with complementary operations across banking, brokerage and asset management.

It has a unique business model that has resulted in very strong fundamentals, given that it has sector-leading efficiency, profitability and capitalization.

This superior profile more than justifies its premium valuation and further upside comes from its strategy of expanding FinecoBank’s product offering.

FinecoBank (OTC:FNBKY) has a unique business model within the European banking sector and its valuation is still attractive considering its fundamentals and good growth profile. The bank is very well positioned to grow organically, both from supportive industry trends and its own projects to expand its product offering. This should lead to higher margins and profitability, justifying a higher valuation in the medium-term.

Company Description

Fineco is the direct, multi-channel bank of UniCredit (OTCPK:UNCRY), which is its main shareholder with a stake of 35%. It operates as a separate brand and its business is not operationally integrated within the UniCredit’s commercial bank network.

Fineco was founded in 1999 and its IPO was performed in 2014. It currently has a market capitalization of about $7.4 billion and trades in the U.S. on the over-the-counter market, but investors should notice that its primary listing is in Italy and has much more liquidity in that market.

Business Profile

Since it started operations in 1999, Fineco’s strategy has been focused on online banking. It has developed a user-friendly platform from scratch, allowing it to offer a range of financial services, including banking and investment products. Fineco’s business profile is quite unique in Europe because it is a mix of brokerage services, banking operations and asset-gathering services to retail clients.

The bank has an integrated business model combining direct banking and financial advice, with a single free-of-charge account. This account includes a full range of banking, credit, trading and investment services, which is the basis of its “One-Stop Solution” business model. Therefore, its main competitors include companies with different business models, such as Azimut (OTCPK:AZIHY), Banca Mediolanum (OTCPK:BNCDY) or IG Group (OTCQX:IGGHY).

Its organizational structure is based on operational functions rather than products and its business is well-diversified across its activities. The banking sector generates about 48% of revenue, followed by the invest ment division (asset management and private banking) with a weight of 32%, while the brokerage segment generates 20% of revenue. Geographically, Fineco’s revenues are almost all generated in Italy.

Fineco is the leading bank in Italy for equity trades in terms of volume of orders and the top online broker in Europe for numbers of orders executed. Its market-share in equity brokerage in Italy is close to 19%, more than double that of its closest peer. It also has the third largest financial advisory network in Italy, with more than 2,600 personal financial advisors.

Growth

The bank has an impressive growth track record and has been a major beneficiary of the most recent trend of digitalization in the banking sector and the rising need for financial advice. Additionally, the banking industry has had some tough years in Italy since the global financial crisis, which has been good for banks and asset managers in Italy that have large independent advisory networks.

Given this background, it is no surprise that Fineco’s organic growth history has been quite good, measured by the number of clients, asset growth and profits. Over the past four years, its financial assets compounded annual growth rate [CAGR] was 11%, clients increased 8%, revenues were up 14%, while costs increased by only 6%. This shows the quality of Fineco’s business model and its good operating leverage.

Despite this strong growth history, Fineco continues to have very good growth prospects due to structural trends shaping the banking industry, namely fintech and the increasing need for investment advice. This should continue to support Fineco’s adding new clients and inflows in the coming years, which should translate in top and bottom-line growth. Additionally, Fineco also has further growth potential from its new projects.

A couple of years ago, Fineco wanted to complete its banking offering, in line with its model to cover all clients’ financial needs through a single account, and started to provide mortgage loans at the end of 2016. Usually clients have a deeper relationship with the bank where they have the mortgage loan, thus this is quite important to make Fineco the first bank of choice for its clients. The mortgage offering is for new loans or for existing mortgages held at other banks and should be an important product to add new clients and extend cross-selling to current ones.

Going forward, Fineco’s growth strategy is based on the expansion of lending services, namely consumer loans, and the establishment of an in-house asset-management business. This unit will allow the bank to sell Fineco-branded fund-of-funds products, something that in the past much likely wasn’t possible within the UniCredit group. Given that UniCredit sold in the past year its asset management unit Pioneer to Amundi, Fineco seems to have now more freedom to develop its own asset management business and earn higher margins through its own funds rather than being just a distributor of third-party funds.

Financial Overview

Regarding its financial performance, Fineco has delivered consistent results over the past few years, due to its diversified business model. This has resulted on strong organic growth, posting growing revenues, good cost control and operating leverage, sound credit quality and superior profitability.

In 2016, Fineco maintained a positive operating momentum, reaching another record year. Its net sales amounted to more than €5 billion ($6.2 billion) and total financial assets reached more than €60 billion ($74.4 billion).

Regarding its top-line, Fineco has a different revenue mix than retail banks with fees being the largest revenue source (55% of revenues), while net interest income [NII] only represents about 45% of revenues. This makes Fineco’s business profile more similar to asset management companies than retail banks, which have usually more than 60-70% of revenues generated from NII.

This revenue mix clearly shows the high importance of fees for Fineco’s business model, given that it is its largest revenue source and has better growth prospects. Commissions from investing products are the most important part of overall fees, representing around 68% of the total. Its brokerage fees, which are more volatile, have a weight of about 24%, while banking fees are increasing rapidly due to the bank’s strategy of pushing for new lending, but still have a weight on total fees of only 8%.

Within its banking operations, its business model has been quite simple in the past, which has been basically an operation of collecting deposits from customers and investing mainly in UniCredit bonds. This has resulted in a balance sheet composition on the asset side that is too much exposed to UniCredit. Fineco has a large portfolio of UniCredit bonds, which amounted to about €11 billion ($13.6 billion) at 30 September, 2017, yielding around 2%. These bonds represent about 55% of Fineco’s assets and is a too large concentration risk for Fineco in the long term.

Fineco acknowledges this and has been reducing gradually its exposure to its main shareholder. Income from these bonds has represented historically more than 80% of Fineco’s net interest income, but the bank has in the past couple of years reduced the reliance on this income source. In the past three quarters, interest from these bonds reduced to around 70% of NII, and Fineco does not want to reinvest the proceeds of more than €1.7 billion bonds maturing in 2018 (15% of the current portfolio).

Therefore, Fineco should continue to gradually increase its net interest income diversification in the next few quarters, both through a smaller bond portfolio and growth from new lending. Indeed, Fineco is increasing its consumer and mortgage lending strongly, which have higher yields than the bonds maturing, thus the expansion of its banking activities will be a strong driver of NII growth in the near term.

On the cost side, Fineco has a very flexible cost structure due to its different business model. Given that its operations are based on online and financial advisors are not employed by the bank (earn about 50% of commissions on new volumes), Fineco’s costs are very well aligned with its revenues and its fixed cost base is very efficient.

This explains why the bank has a sector-leading cost to income ratio of about 40%. This is among the best efficiency ratios for European banks and asset managers, which is another distinctive factor of Fineco’s business model. Its recent project to create in-house asset management capability may put some pressure on its cost control over the next few quarters, but the bank has potential to capture a larger part of the fee margin. Thus, in the medium to long term, its C/I ratio should remain at sector leading levels and may even be better than currently is, depending on the success of its branded funds. Another issue that may affect its cost management is the need to keep investing in digital capabilities, as the rest of the banking sector catches up on digital offerings.

Another positive factor of Fineco’s business model is its high credit quality. Its provisions for loan losses have been very low over the past few years, as Fineco’s non-performing loan ratio is close to zero. Thus, credit risk doesn’t seem to be an issue contrary to many Italian banks. However, as the bank’s current strategy is to expand its credit offering, higher loan losses may be possible in the future.

Due to Fineco’s good top-line momentum, cost control and superior credit quality, its net profit increased by 11% in 2016, to €212 million ($263 million). Its return on equity [ROE] ratio, a key measure of profitability within the banking sector, was 43%.

This level of profitability is outstanding, given that compared to other European banks this is by far the largest ROE and compared to asset managers this is also a sector-leading ROE. For comparison, Intesa Sanpaolo (OTCPK:ISNPY) is one of the most profitable Italian banks with an ROE of 13%, while its asset manager peer Azimut has an ROE of 25%.

This clearly shows that Fineco is extremely profitable and this is a strutural factor supported by its business model. Fineco has a large exposure to activities that require low levels of capital, namely brokerage and third-party fund distribution. Given that the bank act as an 'intermediary' agent, it does not take risk in its balance sheet. Additionally, it has a relatively low loan book and its operations are performed mainly through online channels, making it a cost-efficient operation. Therefore, Fineco's high ROE is a structural feature justified by its capital-light business model.

During the first nine months of 2017, Fineco has maintained a very good operating momentum. The number of clients increased by 7.2% year on year (yoy), while financial assets were up by 13.5%. Net sales amounted to €4.7 billion ($5.83 billion), up by 19% from the previous year. Revenues were up 6.3% to €431 million ($534 million), with lending income performing very well (+41% yoy) due to its strategy of expanding its credit offering.

Fineco’s cost control remains good, with operating costs up by only 2.3%, leading to even higher operating leverage. Its net profit increased by 7.8% yoy to €157 million ($195 million) and its ROE was 39%.

Going forward, Fineco should maintain a solid growth path due to its expanding loan book and growth in assets under management. It has a target for annual revenue growth of 4%, which seems to be easily achievable given its strong growth prospects. Due to its operating leverage, Fineco should continue to expand its margins, leading to higher earnings and profitability levels in the coming years. Its asset management unit is expected to go live by the end of the second quarter of 2018 and should be an important growth source in the next few years.

Capital & Dividends

Regarding its capitalization, Fineco has a very solid balance sheet due to its good credit quality and exposure to capital light activities of brokerage and asset management. At the end of September 2017, its core equity tier 1 (CET1) ratio was 20.7%, among the best in Europe.

Only a few Swedish banks have higher capital ratios and those banks are heavily affected by expected RWA inflation coming from the recent regulatory reform (Basel IV), thus Fineco has the potential to become the best capitalized bank in Europe (measured by CET1 ratio) in the next few years.

Therefore, Fineco currently has an excess capital position and its strategy of expanding lending capabilities is clearly supported by this strong capitalization, given that the bank can easily absorb potential future credit losses without putting its business model in jeopardy. Furthermore, the high level of non-performing loans in Italy is mainly an issue of lending to small and medium enterprise companies, while Fineco targets retail customers. Thus, Fineco seems to have plenty of room to develop its lending offer and gain clients from competitors.

Regarding its shareholder remuneration, its dividend history is very recent because the bank was only listed in 2014. In 2016, its dividend was up by 40% to €0.28 ($0.35) per share, showing a strong confidence in the business prospects. At its current share price, Fineco offers a dividend yield of about 2.90%.

Due to its strong capitalization, its dividend payout ratio was 85%, which is sustainable because the bank is highly profitable and does not need to retain earnings. In the next few years, its dividend is expected to increase at about 10% per year, while its dividend payout ratio should be around 80%. This seems to be a conservative assumption and Fineco can beat current expectations if it decides to distribute almost all of its earnings to shareholders.

Regarding risks, one of the most important seems to be overhang risk. Fineco is controlled by the Unicredit group and the bank may decide in the future to sell or downsize further its stake. Fineco was initially listed in 2014 when UniCredit sold 34.5% through an IPO and further placements occurred in 2016, when UniCredit had a weak capital position and used gains from Fineco’s sales to boost its capital levels.

Thereafter, UniCredit performed a huge capital increase at the beginning of 2017 and currently has a comfortable capital position. Since the capital increase UniCredit did not sold any further stake in Fineco and the overhang risk seems to be low in the short term, but if the bank worsens its capital ratios it may decide to sell its stake in Fineco.

Additionally, Fineco is also exposed to the economic environment in Italy and capital markets performance. Its current strategy of expanding its loan book may also represent a risk in the long term because its underwriting criteria will only be tested in a future economic recession.

Conclusion

Fineco has a unique business model within the European banking sector, with a good growth history, sound credit quality, superior capitalization and profitability. Despite this, its growth prospects are still good due to its strategy of expanding its credit offering and the set-up of its own asset management business.

Due to this sound business profile, Fineco trades at a premium valuation to its peers, which seems to be more than justified by its quality status and good growth prospects. It is currently trading at 24x forward earnings and 9.6x book value, which may seem excessive at first sight, but is warranted by the bank’s superior fundamentals.

These valuation multiples are a result of several factors, of which growth, excess capital and profitability are the most important ones. Within the banking sector, a high-quality business model and an excess capital position usually lead to a premium valuation over the long term, justifying why Fineco currently trades at high valuation multiples.

The P/BV is usually the most used multiple to value banks because it can be used throughout the economic cycle. Also, taking into account Fineco's unique business model within the European banking sector, a relative valuation analysis doesn't seem to be adequate to value Fineco.

Thus, an absolute P/BV valuation is the best approach, based on a variation of the Gordon Growth Model. Assuming that Fineco's sustainable ROE is above 40%, its terminal growth rate is 2% and that Fineco’s risk profile is low, leading to a cost of equity of about 6.5%, assuming an Italian equity risk premium of 5%, this means that Fineco’s deserved P/BV is about 10.4x book value.

This shows that Fineco's current valuation does not fully reflect its fundamentals and could be even higher if Fineco achieves a higher ROE in the next few years, supported by its good growth prospects and business expansion.

Therefore, even though Fineco’s current multiples are high, the stock is not expensive and may have interesting upside of between 10-20% (P/BV 11-12x), if its current strategy of expanding credit and developing its own asset management business becomes successful and lead to a higher ROE in the next few years.

Disclosure: I am/we are long FNBKY, ISNPY. 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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.