BBVA - BBVA: A Compelling European Bank Value Bet

2023-06-29 19:03:24 ET

Summary

• BBVA, the second-largest Spanish bank with significant exposure to the Spanish and Mexican economies, has shown strong financial health and growth in its gross income and net attributable profit, despite banking crises in the US and Europe.
• The bank's focus on digitalization and cost containment, including reducing the number of branches and ATMs, has contributed to its growth and has the lowest efficiency ratio among its European competitors.
• From a valuation perspective, BBVA appears to be a good investment at current prices, even considering potential impacts of a recession, making it a suitable choice for conservative value investors.

Banco Bilbao Vizcaya Argentaria S.A.’s (BBVA) valuation suggests that the company is worth allocating to at current prices for a conservative value investor. It is mostly exposed to the Spanish and Mexican economies, where it stands to benefit from increased digitalization and cost containment strategies.

Introduction to Company

BBVA, or, Banco Bilbao Vizcaya Argentaria, is the second-largest Spanish banking concern operating primarily in Spain, Portugal, Mexico and South America. It offers traditional banking services, such as loans, mortgages, insurance, and investments to both retail and wholesale clients, i.e. consumers and firms of all kinds. Its headquarters is located in the Spanish city of the same name, Bilbao. Its current focus is on improving its digital channels as well as sustainability measures as well as containing costs.

Business Overview

Being the largest bank in Mexico and the second largest in Spain, it comes as no surprise that the largest shares of its 2022 Gross income come from those two countries, respectively.

The company experienced growth in its Gross income from the 2021 figure of 20854 mm EUR to 25219 mm EUR in 2022, a YoY percentage growth of about 21%. Meanwhile, its Net Attributable Profit underwent a YoY percentage growth of 31 % from 5590 mm EUR to 7342 mm EUR. Although 43 % of its Gross income stems from Mexico, as much as 57% of its Net Attributable Profit is from its Mexican business segment, meaning its forward results are much dependent on the broader Mexican economy.

Notably, the three important areas Spain, Mexico, and South America, all experienced growth in Net Attributable Profit. Traditionally, these economic areas are also considered more fragile than, say, the Nordics, making the bank's stock a riskier one than a Nordic bank's.

Its most recent Q1 2023 indicate that the company is on track to delivery another repeat or better than 2022. Annualized, its Q1 Gross Income is 27832 mm EUR, indicating about 10 % growth from 2022. Q1 Annualized Attributable profit stands at 9512 mm EUR, a 29.5% increase from 2022 levels. This further substantiates it as reasonable to project out substantial growth in the valuation below.

Banking Crises

In short, BBVA appears unaffected by both the regional banking crisis in the US and the downfall of Credit Suisse and is actually the first AT1 bond issuer after the UBS takeover of Credit Suisse. CEO Carlos Torres Vila emphasizes the company’s strong financial health, diversified business, profitability, and its liquidity position.

The company has a quick ratio of 1.38, indicating no problems with meeting its short-term obligations. Nonetheless, one should not place too much trust in financial ratios with banks, as the Credit Suisse situation has shown.

Digitalization & Cost Containment

In 2022, the company added 11 mm new customers to its customer base with 55 % of them signing up through digital channels which it continuously invests into. Also, a large part of its 2022 growth came from its Cost Containment Policy which aims to keep costs constant or even better, lower them. By digitalizing the lower value-added tasks in to self-service, greater profit margins can be achieved as well focusing on higher value-added tasks, thereby benefitting the investment thesis. Whilst one of the core pillars of the company’s strategy is cost containment, it already has the lowest efficiency ratio 43.3% among its other large European competitors Barclays, BNP Paribas, Credit Agricole, CaixaBank, Deutsche Bank, HSBC, ING Groep, Intesa Sanpaolo, Lloyds, Nordea, Santander, Société Générale, UBS, and UniCredit.

As a way of cutting costs, the company has reduced its number of branches from 7432 in 2020 to 6040 in 2022. It has also reduced the number of ATMs from 31000 in 2020 to 29807 in 2022, thereby having a lot more room for cutting costs through digitalization in the coming years.

Inverted Yield Curve

Many people take the inverted yield curves in both Mexico and Spain as recession signals but in the banking world, it has a much more direct impact. During a steep yield curve, a bank is able, through its practice of borrowing short-term and lending long-term, to earn the difference, or the Net Interest Margin. Currently though, global yield curves are flat to inverted, indicating low Net Interest Margins on new loans. Although this can be seen as a sign of impending larger Net income growth, historically, it has been best to avoid holding bank stocks through a recession.

Valuation

Through its cost containment as well increasing the number of customers through digitalization, it seems more than fair to expect a slight growth in its yearly free cash flow of 2%. Also, I will use both the 5-year average and the 10-year average of its per-share free cash flow. With a discount rate of 8 % and a terminal multiple of 10, the two scenarios result in a per-share value of 12.51 USD and 19.58 USD, respectively:

A recession aside, the company should be able to even grow its free cash flow through its strategy which would increase the intrinsic value in the scenarios above. In case of severe recession, one might expect the company to go without free cash flow for two years. Also, the market would most likely be willing to pay a lower terminal multiple, say, of 5. These assumptions result in a per-share value of 7.8 USD which is actually near the NYSE ADR price of 7.58 USD on June the 29th:

Conclusion

There are many reasons to be cautious when investing in financial sector companies but, from a valuation perspective, BBVA seems to be in between cheap to fair value at current prices, making an attractive investment. As a conservative value investor, I would be willing to invest at least a small stake at current prices.

For further details see: