- I presented Norway's biggest bank in December of 2019. COVID-19 pushed this bank down, and I loaded up massively during the drop.
- DNB is now my 4th-largest financial stake.
- Short-term performance has been spectacular - long-term promises even more.
- DNB is a "BUY" at this time.
I've continued to invest in financial stocks during most of the crisis with relative regularity. The difference is, I've been extremely picky about my financial investments and focused for the most part on non-Scandinavian picks, such as Ameriprise Financial (AMP), Reinsurance Group of America (RGA), Visa (V) and others.
There was one exception to this, however.
The dual trends of a weakening Norwegian crown - NOK - combined with a global pandemic wreaked havoc even in the very conservative Norwegian financial market, and a bank which typically trades at extreme premiums compared to peers, was suddenly very buyable both from an FX point of view, with the NOK/SEK pairing being 1:1 or even in favor of the SEK, and the share price being down almost 30-40%.
So, I invested - and I invested a lot, knowing full well what would most likely happen when things turned around. DNB (OTCPK:DNBHF) (OTCPK:DNHBY) was sadly one of the only investments where I dared pull out all the stops and increased the stake to my desired size of nearly 2% at a very cheap price.
I bought more than $10,000 worth of dividend reinvestments and capital injections worth of stock as the price crashed to levels nearing 100 NOK/share. Today, that position has appreciated significantly and stands at a gain of 37% in less than 6 months, and it hasn't even appreciated back to pre-pandemic levels yet. My YoC on the LTM dividend is close to 8.8% for what is without a doubt one of Scandinavia's best banks.
Let's look at how the first quarter went for DNB.
DNB - How has the company been doing?
The quarterly results for banks have been heavily impacted by COVID-impairments, credit loss provisions and banks reviewing their current operations and risks to make sure that they have what is required to handle the potential headwinds coming up due to Corona.
What's different for DNB is that the bank also has significant oil-related exposure, which has made itself known through negative RoE development for the quarter as well as a few other things.
On the surface, we have:
- 1Q20 YoY RoE of -6.5%, with a TTM RoE of 9.8%, down from 12.5% in 1Q19. This is mostly due to COVID-19 as well as oil.
- Net interest income (NII) is up almost 12% on a YoY basis and 0.5% on a sequential basis. This was due to repricing and favorable customer volumes.
- Net commission income (and fees) up 0.8% YoY, with a strong first two months offsetting the March COVID-19 effects.
- DNB recorded an impairment provision/s of 5.8B NOK due to both COVID-19 as well as the unprecedented drop in oil prices, which have negatively affected forecasts.
It is, therefore, a mixed bag. Underlying results and fundamental operations remain strong, but we can see an economic effect that's not as apparent in Swedish peers, due to both currency effects as well as the increased exposure to oil/energy, which peers do not share.
While the negative effects have been considerable, we're also talking about the richest nation in the world (Source: The World Bank). Something as comparatively small as COVID-19, which at the time of writing this article is slowly adjusting, won't more than slightly budge Norway's economy to any sort of degree. The economy of our neighbor remains strong, and the nation has plenty of room for additional fiscal stimulus, should it deem it necessary. Norway remains one of the last European countries to have a positive key policy rate.
(Source: DNB 1Q20 Presentation)
Norway was also, together with other Scandinavian nations, one of the best-prepared to handle the pandemic from a bank business operations point of view. Internet users and digital transactions form the vast majority of all customer interactions with DNB, and it has guaranteed continued availability throughout the entire pandemic. Over 98% of Norway's population has internet access, and customer interactions with DNB are 79% mobile, 19% Desktop, and only 2% via Telephone, Chat, or branch office visits.
I pointed to this previously in my original article, but DNB also has an extremely solid foundation to stand on. DNB has a CET1 ratio of nearly 18% and a leverage ratio of 6%. In the 2018 EU-wide CET1-capital stress test, DNB scored the 4th-best in all of Europe (and guess which nation's banks were higher...)
(Source: DNB, 1Q20 Presentation)
However, let's talk trouble. Unlike Swedish peers, DNB is heavily impacted oil. Take a look.
(Source: DNB, 1Q20 Presentation)
Unlike peers, DNB has significant comparative exposure to Oil, gas, and offshore at ~5% and another 17% impact to shipping and other services. DNB is, after all, one of the largest shipping financers in the world. In this, DNB can't compare to a bank like Handelsbanken (OTCPK:SVNLF), with virtually no/very little exposure to the same sectors.
However, over 50% of the bank's portfolio is considered to be a "high-quality" with personal customers, with 87% of it being home mortgages. The bank also has very little consumer finance exposure and has a significant buffer in terms of the LTV ratio - 60.6%. Unlike other nations, very few customers are ever in danger of defaulting, due to the welfare system in Norway which is in some ways even more generous than Sweden - there are supports that address debt servicing and other needs during these difficult times.
Let's focus a moment on the 1Q20 oil results. Challenges for DNB here are numerous, even if it's "just" 5% of the total portfolio. Offshore operations have an uncertain outlook given current trends, but DNB considers the number of customers to be quite manageable. The bank also considers most oil and gas manageable due to a flexible cost base, hedges, and strong collateral. The fact is, however, the actual exposure to offshore has increased due to FX, and the company's offshore and rig operations account for around 40% of the bank's 109B NOK Oil/gas EAD (exposure at default) again, a significant amount. The fact is that company exposure to higher default probabilities have increased significantly only in the last year.
(Source: DNB, 1Q20 Presentation)
So for anyone considering an investment into DNB at this time, you do want to look at these things prior to investing. They will likely affect profits for at least this year, and possibly more.
Aside from this, the positive underlying fundamentals are recurring in every sub-sector of the bank's clients. This includes shipping (where little has changed in terms of risk, PD has actually gone down and the company has no net stage-3 commitments as of 1Q20 here), commercial real estate, and others. Nonetheless, the uncertainty in the economic outlook has made the bank expect increased credit losses as well as a large GDP decrease for Norway. Because of this, we see the impairments here.
However, growth in loans and credits, as well as deposits, are in line or above expectations...
(Source: DNB, 1Q20 Presentation)
...and the bank even managed to grow fees and commissions in the face of COVID-19, mainly due to increased asset management volume and sales of insurance products.
To conclude here, I also want to mention the Company FY19 dividend (payable 2020). It's been postponed. The message is that the Dividends for 2019 as well as the share buy-back authorization is to be decided at a postponed AGM no later than December 2020. The AGM has been set for June 30th in 2020 - a few weeks.
Let's look at valuation.
DNB - What is the valuation?
First off, the COVID-19 impacted valuation in May was still considered appealing enough that many insiders chose to purchase stock. A full list below. It's important to note, however, that DNB has some active insiders, with frequent purchases at prices of ~150 or below.
(Source: DNB, Acquisition of shares by primary insiders, 04.05.2020)
So clearly some people consider the current price good enough to justify insider purchases.
In my initial article, I lined out that DNB is extremely rare to be found at undervaluation, and times when DNB approaches 5%+ in yield is when I start paying attention. It makes sense therefore that I increased my purchasing pace when I saw an 8-9% yield for the bank. I also wrote that:
When valuing banks, RoA (Return on assets) is of central importance. We may expect a "good" bank such as DNB to have a RoA of at least 1% or above - it does not. Current DNB RoA falls in the realm of other Nordic banks, and comes in at about 0.82%. Warren Buffett would, because of this, perhaps expect DNB to trade at <1X to tangible book.
However, despite this, and because of this expecting a sub-1X price/tangible book value, the bank still trades at 1.09X of tangible book, meaning according to some valuations, it could still be considered overvalued (Source: TIKR.com).
At this time, these valuations have of course changed dramatically. Tangible book is down from 1.09X to 0.7X during 1Q20, bringing the bank to true, long-term undervaluation both with regards to historical metrics but also, potentially the long-term earnings potential. I bought large parts of my stake even below that level. Given current earnings potential and book value, we're currently looking at a tangible book value of 0.94X.
While we're no longer seeing grotesque sort of undervaluation, the price today is still appealing when we consider long-term trends.
Currently, analysts are expecting an FY20 EPS of around 9.7 NOK/share, signifying a drop of around 37%, followed by recovery during 2020 bringing the EPS back up to 2017-2018 levels of around ~12-13 NOK/share (Source: S&P Global). Prior to the pandemic, DNB had also announced a competitive dividend, which now is instead expected to be about halved at the AGM in a few weeks, bringing it to ~5 NOK/share, a cut of about 43%. It's expected to rise above 7.5 NOK/share in 2021.
If S&P global estimates turn out accurate, this would indicate current yield of around 3.5%, to rise to a 5.2% yield next year - this is neither illogical nor imprudent and may very well materialize as such. As we don't have any sort of clarity here yet, however, I choose to value DNB by the long-term implications of its underlying business. While there is an increased risk from Energy/Oil and specifically off-shore assets, I don't see that much has changed in terms of the bank's long-term valuation. It's still the primary choice for most Norwegians.
In my original article, I hoped for a valuation drop to below 1X in terms of tangible book. That's where we are now. The bank's P/E is distorted by current earnings pressure due to COVID, but if we allow for an LTM or 2019 P/E valuation, we're looking at a current multiple of almost 9X. This is still somewhat higher than Swedish peers, and the P/E value based on NTM earnings is closer to 10X, but with respect to what DNB represents long-term, I view this as materially more attractive than it was in December in 2019 when I initialized my position.
I view DNB as being worth conservatively at least 11 times its long-term earnings potential. That long-term earnings potential isn't, as I see it, the earnings we see during a pandemic. Rather, it's more accurately an average of the past few years, which come to around 13.8 NOK/share and brings the target to a share price of around 152 NOK/share - an upside of at least 8.5% from the current share price.
What we can see is therefore that the opportunity from COVID-19 in terms of the bank's overall valuation is nearly over. We'll probably experience some smaller ups and downs as a result of the coming recovery - perhaps we'll even dip back down. This article serves to establish just where I would go ahead and buy more of the company. This leads me to my current DNB thesis.
Despite some of the negativity and risk mentioned in the article, DNB remains one of the better and safer banks on the planet, in my view. Its exposure to shipping and oil means it has a less desirable risk profile, at least for the time being, but this is likely to shift going forward. We can also expect even for these sectors to recover sooner or later. Regardless of these things, however, DNB sports one of the best CET1-ratios and safeties of any bank in existence, and even a complete collapse in their at-risk assets wouldn't put the bank's fundamentals at any sort of long-term risk.
DNB is also a good way to gain exposure to Norway's economy, given the bank's position in domestic society. It's shareholder-friendly, qualitative, and well-structured. It doesn't share the worries of Swedbank (OTCPK:SWDBF) and reminds me more of Handelsbanken - at least a Norwegian version of it - than a bank with high-risk factors.
So, due to the current valuation and overall characteristics of the bank, I encourage readers who find themselves in need or want to extend their exposure to finance - and international finance - to take a look at DNB. Look beyond the current dividend troubles, as these will disappear with corona. Look to this bank's fundamentals - the largest bank in all of the richest nation on earth - and look if you'd like exposure here.
My own stance, at 2.5% portfolio exposure, is clear enough, and DNB is currently a "BUY".
Thank you for reading.
While undervaluation is not as distinct, DNB still sports a 7-8% potential upside at today's price. DNB is a "BUY" here.
This article was written by
Wolf Report is a senior analyst and private portfolio manager with over 10 years generating value ideas in European and North American markets.He is a contributing author for the investing group iREIT on Alpha where in addition to the U.S. market, he covers the markets of Scandinavia, Germany, France, UK, Italy, Spain, Portugal and Eastern Europe in search of reasonably valued stock ideas. Learn more.
Analyst’s Disclosure: I am/we are long DNBHF, DNHBY, SWDBF, SVNLF, AMP, RGA, V. 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.
While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.