Erste Group Bank: Trading At 6 Times Earnings And A 7% Dividend Yield (OTCMKTS:EBKOF)

Introduction

In my previous article on Erste Group (OTCPK:EBKOF), I argued that based on the Austrian bank’s dividend policy and anticipated earnings, shareholders would be able to look forward to a dividend yield of 8%. Erste Group released its results a little while ago, and I was pretty satisfied to see the bank will pay a dividend of 2.70 EUR based on its 2023 results. I have been flip-flopping about actually initiating a long position in Erste Group as, on the one hand, I like its exposure to Eastern Europe. But on the other hand, it’s quite a politically volatile region and I already have some exposure through my indirect investment in the KBC Group (OTCPK:KBCSF) (OTCPK:KBCSY) which I recently discussed in an article.

And just to be clear: Erste Group has no banking activities in Ukraine or Russia.

Erste’s primary listing is on the Vienna Stock Exchange, where it’s trading with EBS as its ticker symbol. Considering the average daily volume in Austria is approximately 475,000 shares per day, it should be the preferred trading venue for most shareholders as the daily volumes are clearly superior to any of the secondary listings. All relevant documents and financial information I will be referring to can be found here.

2023 was a strong year for the European banking sector

Whereas US-based banks are facing choppier waters, European banks seem to be navigating through current volatile times without too much effort. One of the main reasons – I think – is that European banks prefer to maintain a healthy cash balance over debt securities, and, as such, the amount of unrealized losses on debt securities is generally lower. Erste Group, for instance, only owns about 10.3B EUR in debt securities and this represents just over 3% of the balance sheet total. On the other hand, it has almost 37B EUR in cash on the balance sheet, which represents roughly 11% of the total amount of assets. This obviously doesn’t mean there are no unrealized losses on the fair value of the loan book, but as those are not marked to market and the valuation only comes into question when there is a need to liquidate assets, it’s a non-issue for now due to the bank’s excellent liquidity position and access to additional liquidity.

And whereas US banks are having difficulties dealing with a decreasing net interest income, European banks did pretty well and Erste Group also saw an increase in its net interest income by in excess of 20% to just over 7.2B EUR. Although the interest expenses increased by a factor of 2.7, the interest income almost doubled and in absolute numbers this resulted in a 1.3B EUR increase in the net interest income.

The income statement above also indicates the bank saw an 8% income in the net fee and commission income while there was a positive trading result, partially offset by unrealized losses on the debt securities. Meanwhile, the net impairment result on the financial instruments (comparable to the “loan loss provisions” in the US) decreased from 300M EUR in 2022 to 128M EUR in 2023. The total amount of new loan loss provisions was 264M EUR (a decrease from the 336M EUR in 2022) but the bank was also able to recover some of the previously recorded provisions, which explains the relatively low loan loss provision.

The bottom line indicated a net profit of just under 3B EUR, which represents an EPS of 7.12 EUR based on the current share count of 421M shares (the average weighted share count during 2023 was higher as the bank completed a buyback program). The bank will pay a dividend of 2.70 EUR per share, which represents the lower end of its 40%-50% dividend payout ratio. The dividend withholding tax rate for individual shareholders is 27.5%.

The outlook for 2024 is a bit mixed. The bank expects the loan book to continue to grow but expects a 3% decrease in its net interest income. According to the accompanying statements, the lower NII shouldn’t have a noticeable impact on the bottom-line results, as Erste mentioned the minority interests in the savings banks division will absorb the majority of the NII decrease. Additionally, Erste calls it the “consolidation” of the net interest income after two years of strong growth.

An important part of the 2024 guidance is the risk cost guidance. Erste expects to keep its loan loss provisions below 25 bps, and while the 25 bps still represents a substantial increase versus the 6 bps net loan loss provision in 2023, it would still be very manageable. A total cost of risk of 0.20% would for instance have a negative impact of approximately 300M EUR on the pre-tax income, and that’s just 6% of the 2023 pre-tax income.

The bank also is guiding for a return on tangible equity of in excess of 15%, and given the total amount of equity on the balance sheet while adjusting for the intangible assets and non-controlling interests (assuming a pro rata split of the intangible assets), this implies the net attributable income will come in at approximately 2.7B EUR. And assuming the bank completes its new 500M EUR share buyback program, the share count will likely decrease to 410M shares (or even lower) by the end of this year, which would subsequently result in an EPS of 6.5-6.6 EUR per share. And just to be clear: This includes the anticipated increase in the loan loss provisions.

Investment thesis

The bank appears to be cheap based on a price to book multiple (approximately 0.8 times the tangible book value) and earnings multiple (trading at approximately 6 times earnings) while the capital ratios remain relatively strong. The regulatory minimum CET1 ratio by the end of this year will increase to 11.35% as the regulator requires a higher counter-cyclical buffer and a higher buffer for a bank with systemic importance, but with a CET1 ratio of approximately 15.6% at the end of 2023 the bank will have no issues meeting the increased CET1 ratio requirement. And based on a 40% dividend payout ratio and the anticipated spending of 500M EUR on a share buyback program, the bank will retain approximately 1.1B EUR in earnings this year, which would boost the CET1 ratio by 70-80 bps anyway. As such, I think it’s likely that – barren unforeseen circumstances – Erste Group may end this year with a CET1 ratio of close to or even exceeding 16%.

I currently have no position in Erste Group, but the bank has proven in 2023 it has been able to take advantage of the increasing interest rates on the financial markets. While the net income will likely be slightly lower in 2024 due to the exceptionally low cost of risk recorded in 2023, the bank remains attractively priced, and I may consider initiating a long position, but this won’t happen in the next 72 hours.

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.