Credit Agricole - Don't Let A Dull Business Plan Put You Off

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About: Crédit Agricole S.A. (CRARF), CRARY, Includes: BNPQF, SCGLF
by: Regents Research
Summary

Credit Agricole recently presented a new 3-year business plan to the market. It was greeted with what might politely be described as utter indifference.

It would be a mistake to let this detract from the very compelling attractions of the Credit Agricole investment story (that I outlined in previous article).

French bank business plans should always be taken with a pinch of salt - they usually define the absolute minimum of what is achievable, not the maximum.

Credit Agricole has form on this front - it's last 3-year plan was achieved a year early and the targets were beaten.

The upside I see in the stock doesn't need big new earnings promises. Instead it comes from cost-of-equity reduction and the pricing out of an extremely large discount to current sum-of-parts.

Credit Agricole's new Medium Term Plan - try not to yawn

Credit Agricole (OTCPK: OTCPK:CRARF, OTCPK:CRARY) presented a new 3-year business plan to the market on 6 June. It was greeted with widespread indifference by investors and the stock price hardly budged.

This is not a surprise since the earnings promises contained in it align pretty much precisely with where Street estimates are already at.

In brief summary, the main points are:

  • A target of at least €5bn net profit by 2022 (Street estimates are at €4.9bn). This would be ~3% CAGR from 2018 levels (€4.4bn)
  • A target of ~€22bn total revenues (Street estimates are at €21.8bn). CAGR on this basis is 2.5% pa from 2018 levels
  • 2022 ROTE of at least 11%
  • €8bn of dividend payouts over the period, which equates to at least €0.70 per share per annum (Street estimates see €0.70 this year and €0.73 next).

Source: Credit Agricole Medium Term Plan presentation, 6 June

So far, so uninspiring. The picture seems to be one of meagre growth and 2022 end-state profit levels that are bang in the middle to the range of analysts' current forecasts.

But don't take things too literally

However, a couple of points are worth bearing in mind.

First, 3-year plans of all the French banks are almost always pitched at highly conservative levels in terms of the earnings promises they make. More often than not, the banks don't have much trouble beating them. Generally my impression is they are drawn up as much for internal budgeting reasons as they are as a prospectus to investors.

I accept that BNP (OTCQX: OTCQX:BNPQF) and SG (OTCPK: OTCPK:SCGLF) have recently done their best to disprove this statement: both had to adjust down their targets earlier this year in response to lower than anticipated interest rates and worse than expected market conditions.

But this leads on to the second point to bear in mind, which is that Credit Agricole's track record is much much better.

In fact, the previous plan (to 2019) was delivered a year early and the targets within it were exceeded by a fairly significant margin. Thus, for example:

  • Targeted net profits were €4.2bn and the company actually delivered €4.4bn (in 2018 rather than 2019)
  • The ROTE target was >10% but the company delivered 12.7% in 2018
  • Revenue growth was targeted at >2.5% pa whereas the actual growth rate over 2016-2018 was 4.3%

I would have a high degree of confidence in saying that the 2022 targets will be similarly exceeded and that they represent a minimum rather than a maximum.

The upside in Credit Agricole doesn't need big new earnings promises

The bigger point I'd also make is that, referring back to my last article on Credit Agricole where I laid out the investment case, the upside I see is not predicated on needing big new earnings promises or upgrades to Street estimates. On current Street estimates the stock already looks heavily undervalued.

I outlined two key factors in my previous article that I think will drive the share forward and neither is primarily about the level of profit estimates.

Credit Agricole looks 35% undervalued on sum-of-parts

I’m often reluctant to use sum-of-parts valuation for banks. The main reason is that banks segment their businesses in all sorts of ways that are often not comparable with each other or, more importantly, with listed companies that could be used as benchmarks.

Credit Agricole is different. The reason is that it has two large businesses at its core that are discreet and easily comparable to listed peers. Hence benchmarking them for valuation purposes is fairly straightforward.

In fact, one of them is itself a listed company – Amundi, the asset manager in which Credit Agricole owns a 68.5% stake. The current market value of this stake is €8.3bn.

The other business is Credit Agricole Assurances, which is a leading French life insurer and a big player in the French property and casualty market. It too has plenty of large listed peers that can be used as valuation benchmarks (CNP, AXA, Allianz etc). Credit Agricole owns 100% of CAA and peer valuations suggest this stake is worth ~€12bn.

With CAA and Amundi together being worth ~€20.3bn and Credit Agricole’s market cap. being €31.7bn its remaining businesses are implicitly valued at €11.4bn. However:

  • These other businesses (French retail, investment banking, corporate banking etc) delivered net profits of €2.5bn in 2018, meaning their implied PE is just 4.6x.
  • They collectively have €27bn of tangible equity, meaning their implied price to net asset multiple is just 0.4x. Yet they delivered a 9% return on equity in 2018, which should probably see them valued closer to 1x.

The average price to net asset multiple of commercial banks in Europe is currently 0.8x. Credit Agricole's non-insurance and non-asset management businesses broadly resemble those of a typical commercial bank. So it doesn't seem unreasonable to think they should also be valued at least at 0.8x P/TNAV rather than the 0.4x they are currently valued at. Were they to be so valued, the upside to Credit Agricole's share price would be ~35%.

These calculations are outlined below:

Credit Agricole has been a complicated company in the past and is penalised by a high cost of equity. As it simplifies, this should fall and the share price should rise

Credit Agricole has been somewhat of a no-go zone for some investors in the past because of its complexity. This complexity was brought about by three key issues:

  • First, it is majority owned by Credit Agricole Group (56%), which has effective management control and whose interests have not always aligned with those of minority shareholders in the past. I think this situation has changed radically in recent years and the Group’s input into day-to-day management and strategy is now fairly limited. To all intents and purposes Credit Agricole SA acts like any other value-maximising company.
  • Second, it has historically acted as an acquisition vehicle for the Group, meaning that in its early years (late 1990s to early 2000s) it went on a buying spree of ill-thought out minority stakes in other European banks with which Credit Agricole Group has hazy cooperation/JV ambitions.
  • Third, it has a complicated cross-guaranty structure in place with Credit Agricole Group called “Switch” which it uses to offload some of its regulatory capital requirement (the Group assumes the risk of a certain portion of Credit Agricole SA’s balance sheet in exchange for a fee, effectively an insurance premium). This is an almost unique set up in European banking and universally disliked by investors for its complexity and perceived “gaming” of the bank capital rules.

Credit Agricole has been addressing these issues for several years in a simplification programme that is making the company much more “normal” and palatable to a wider audience of investors, especially outside France.

So, for example it has sold off most of the largest minority stakes. It sold Emporiki in Greece in 2012, a 15% stake in Banco Espirito Santo in Portugal in 2014, a 16% stake in the Eurazeo property investment company in 2017 and another 16% stake in Banque Saudi Fransi also in 2017.

The remaining investments in the non-core, minority shareholding portfolio are now small.

As regards “Switch”, one agenda item in the 2022 Medium Term Plan that was significant was a commitment to halve to size of the guaranty (by 2022). This might be slower than investors would like; most want to see it unwound completely and immediately. But it is an important commitment that goes in absolutely the right direction.

As I said, none of these de-risking / simplification steps is about earnings per se. They are all about lowering the risk profile of the company and achieving a lower cost of equity. Cost of equity is currently high, I estimate 12% (calculated by dividing the 2019 estimated return on equity of 10.5% by current P/TNAV of 0.9x). Even a reduction to 10% would give the share price 15-20% upside without any need for increased profits.

Conclusions

Credit Agricole remains one of my favourite buy recommendations amongst European banks. The Medium Term Plan is dull but it is a sideshow to the real issues that will drive the company’s share price. These revolve around its declining risk profile, declining cost of equity and heavy valuation discount to sum-of-parts.

The stock trades on cheap multiples (0.9x P/TNAV, 8x expected 2019 earnings and 6% dividend yield) and appears 35% undervalued on my estimates. As management continues to deliver on simplification and on increasing profitability I expect to see a step-change upwards in these multiples.

Disclosure: I am/we are long BNPQF, CRARF. 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.

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