The Recent Share Price Drop In 6% Yielding Banco Bilbao Vizcaya Argentaria Is Not Justified

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About: Banco Bilbao Vizcaya Argentaria, S.A. (BBVA)
by: The Investment Doctor
Summary

BBVA seems to be dealing well with the current market circumstances as its net interest margin increased in some core markets.

The Turkish problem appears to be under control.

BBVA is now trading at less than 7X its earnings, and applying a 40% payout ratio would result in a dividend that remains at least stable.

Introduction

BBVA (BBVA) is a Spanish bank but generates just 25% of its net attributable profit in Spain so the bank often gets involved in a sell off when the economic situation in Spain takes a turn. Mexico is so much more important for BBVA with an attributable net income of 1.29B on a 3.06B EUR total net income (before deducting the expenses of the corporate overhead). As such, BBVA should be seen as a banking conglomerate and not as a purely Spanish bank.

Source: Yahoo Finance

After the recent sell off, the bank is now trading at less than 7 times its net income while the dividend yield has increased to 6% despite maintaining a payout ratio of less than 50%. At first sight, it looks like the market is overreacting again and this could be an interesting opportunity to initiate a long position. In this article, I will refer to the bank’s main listing on the Madrid Stock Exchange. All amounts are in EUR, unless indicated otherwise.

Turkey and the net interest margins: Two issues that now appear to be under control

There were two elements that have held BBVA back in the past few quarters and years.

BBVA has a presence in Turkey and the weakness of the Turkish Lira and turmoil in the country have created a negative perception, and as BBVA is one of the larger European players in the country, the bank was sometimes seen as a proxy for the Turkish situation.

It’s still early days but it looks like BBVA has been able to stabilize its Turkish operations as the operating income (at constant exchange rates) in the first half of the year in Turkey (1.08B EUR) increased by 11.7% compared to the 970M EUR in H1 2018. That’s still lower than the 1.4B EUR in operating income generated in the second half of the year, but the net income in the first half of the year increased in Turkey. But applying the current exchange rates would have resulted in a loss as well, that’s for sure, but even after applying the updated exchange rate (which resulted in a net income of 372M EUR in H1 2018), Turkey remains profitable.

Source: quarterly report

Additionally, the loan loss provisions remained relatively stable as well at 337M EUR, but BBVA may have to step up its provisions as the NPL ratio increased from 5.3% to 6.3% while the coverage ratio decreased from 81% to 75%. But there’s also positive news as the cost of risk has decreased, so I’d say the situation in Turkey is under control.

Source: quarterly report

A second issue that got a lot of attention in Europe when some banks presented their financial results are the net interest margins. The CEO’s of ING Bank, KBC Group and Caixabank warned for margin pressure, and this, combined with the rate cut of the Federal Reserve and the lack of measures from the ECB, have sent the bank stocks spiraling down.

But for BBVA, the second quarter remained "business as usual." The net interest margin increased in Spain, Turkey and Argentina, remained stable in Mexico (its most important division) and decreased slightly in the US.

Source: company presentation

We still need to prepare for tightening interest margins, but it looks like BBVA is handling things quite well.

A very respectable result in the first half of the year

Thanks to the strong interest margins and expanded balance sheet, BBVA actually reported a 4.6% (7.1% using constant exchange rates) increase in the net interest income which flirted with the 9B EUR. The gross income also increased by around 120M EUR despite a disappointing trading income result, while the net income also increased by 2.5% thanks to BBVA keeping its expenses under control. The personnel expenses increased by just 0.9% while the "other" administrative expenses decreased by 9.5%.

Source: quarterly report

The pre-tax income did decrease by 5.4% to 4.05B EUR as BBVA chose to increase the impairment charges and provisions (up from a combined 1.79B EUR to 2.04B EUR in the first half of the year), but a the bottom line, the net income attributable to the BBVA shareholders remained virtually unchanged at 2.44B EUR (down 3.7%) resulting in an EPS of 0.34 EUR. That’s just 2 cents per share lower than in H1 2018 despite stepping up the provisions and impairment charges by almost 14%. Sure, it’s never nice to see the bank feels the need to increase the provisions and write-offs on non-performing assets, but it’s even more important to effectively take those steps instead of kicking the can further down the road. And with an operating income of in excess of 6.1B EUR, there’s plenty of leeway to absorb even higher charges.

Expect a stable dividend

Considering the higher impairment charges and provisions are absorbed by the higher gross income, leaving the net income virtually unchanged, it’s reasonable to expect the dividend to remain at least stable (BBVA paid a 0.26 EUR dividend divided into a 10 cent interim dividend and a 16 cent final dividend).

BBVA’s dividend policy is based on paying 35%-40% of the recurring net income as a dividend and considering the H1 net income of 0.34 EUR it would be reasonable to expect a full-year EPS of 0.65 EUR (which would indicate a 10% profit decrease compared to the first semester) which would be required to keep the full-year dividend unchanged at 0.26 EUR per share.

As BBVA’s capital ratios remain robust as well (the phased-in CET1 ratio was 11.8%, the fully loaded CET1-ratio as of the end of June was 11.5%), there’s nothing preventing BBVA from continuing to pay a dividend.

Source: quarterly report

A CET1 ratio of 11.5% doesn’t sound high, but the SREP requirement for this year is just 9.26%, indicating BBVA has 2.24% in "excess" CET1 capital before its ability to pay dividends will be curtailed. Considering the total amount of risk-weighted assets on the balance sheet as of the end of June was 360.5B EUR, the 2.24% in excess CET1 capital represents just over 8B EUR so even if the markets and the world economies take a turn for the worse, BBVA should be fine from a regulatory capital requirement point of view.

Investment thesis

BBVA’s market capitalization lost approximately 8B EUR in the past four months, but although I don’t disagree with the statement to expect a lower net interest margin, I have the impression BBVA is doing a good job in navigating through the storm as it has to deal with the "Turkish issue" as well. The net income decreased a bit because the bank hiked its provisions and impairment charges but I think it’s still realistic to expect a full-year net income of 0.65 EUR per share which wouldn’t just indicate a P/E ratio of less than 7, but would also confirm the current 6% dividend yield.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BBVA over 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.