BBDO - Bradesco: Cleaning Out The Closet

Summary

• Bradesco misses the mark in its latest quarterly earnings report on massive provisions for the Americanas scandal.
• The near-term guidance has also been revised lower amid the asset quality overhang.
• With the bank set to earn below its cost of equity for the foreseeable future, it’s hard to justify a re-rating anytime soon.

Brazilian commercial bank Bradesco (BBDO) recently printed a massive earnings miss and guided down, with recurring earnings declining ~78% YoY on provisioning related to the Lojas Americanas (LOAMF) scandal. While some degree of write-down was expected heading into earnings, the extent of the impact surpassed even the most bearish expectations. Not only is the Americanas provisioning at 100%, but the updated FY23 guide implies an ~12% ROE - for context, Bradesco sustained mid-teens % ROEs even through the worst of the COVID impact. Given the bank's outsized exposure to Americanas vs. the other major Brazilian banks, expect more negative disclosures in the coming months.

Alongside a higher for longer rate environment and the prospect for an economic slowdown in FY23/FY24, it's hard to see much upside to Bradesco's earnings power this year. The <1x P/Book valuation is optically cheap, but the discount is warranted, in my view, given the prospect of ROE running below the cost of equity through the coming quarters. Pending more comprehensive post-earnings adjustments by the Street (likely in the next few weeks), I wouldn't time a bottom just yet.

Big Miss as Bradesco Clears Out its Lojas Americanas Exposure

Expectations were low heading into Q4 - recall that the bank's Q3 2022 results had surprised to the downside, not only due to a jump in provisions but also management commentary indicating that Q4 could see even more deterioration. And with expected breakeven for market net interest income also pushed out to H2 2023, many had earmarked Q3 as the 'kitchen sinking' quarter.

Yet, Bradesco's Q4 still disappointed, as net income of R$1.6bn implied a ~4% ROE (vs. the current Brazilian risk-free rate of 13-14%). Some context is needed, though - a large chunk of the miss was down to outsized 100% provision for the bank's Americanas exposure. But excluding the one-off Americanas P&L hit, net income of R$4.26bn would still have equated to a below par ~10% ROE, reflecting fundamental weakness as well. The only silver lining was in Bradesco's insurance segment (+22% YoY), though the higher cost of risk, fee income weakness, and continued opex pressure more than offset any strength here.

Asset Quality Overhang Adds to P&L Woes

Provisions were the key highlight this quarter, and unsurprisingly, net loan loss provisions were up a massive ~250% YoY to R$14.9bn due to a wholesale R$4.9bn provision for Americanas. Even breaking out the Americanas contribution, though, Bradesco's asset quality would still have been poor. To recap, the 90-day NPL formation came in +46bps higher QoQ at 6.8% (7.2% including the renegotiated portfolio) on deterioration across its individual and small/medium business ((SMB)) book. This compares to a smaller low-teens bps deterioration for key peer Itau ( ITUB ), reflecting Bradesco's relatively lower-quality, retail-focused portfolio. The +50bps QoQ early delinquency was another concern, headlined by a ~110bps deterioration for SMBs amid a challenging operating environment.

While bulls might argue that the asset quality deterioration is a one-off (vs. structural) event, the resulting decline in Bradesco's capital ratio will weigh on the P&L. For context, the tier-1 common equity ratio now stands at 11.0% - ~110 bps lower due to adverse regulatory changes and prudential adjustments, in addition to the P&L impact. Given the bank's concentration on the lower-income segment, as well as underserved regions, Bradesco should suffer more in an economic downturn (and vice-versa). So depending on when real purchasing power recovers and inflation subsides, Bradesco could underperform peers with higher-quality books.

Weaker FY23 Guidance a Sign of Things to Come

Beyond the Q4 letdown, Bradesco's guidance also came as a negative surprise. To recap, net interest income growth is guided to slow to +9% at the midpoint, while net provisions will remain elevated at +38% YoY on an underlying basis (+19% YoY including the Americanas impact). This points not only to more asset quality headwinds in retail (individuals/SMB) but also a more conservative outlook for the wholesale segment in a 'higher for longer' rate environment. Another likely contributor to the disappointing P&L guidance is the smaller loan portfolio as management actively de-risks the Americanas exposure and the resulting impact of lower interest revenue on the loan book.

As the operating backdrop worsens, expect Bradesco to further tighten credit approvals as asset quality deteriorates before bottoming out sometime this year. The flip side of lower origination is lower credit growth, though, alongside a potential NIM reduction. With the CET1 ratio also at ~11% and Bradesco set to maintain high payout ratios, the bank has limited capacity to grow beyond its near-term guidance. So I see a flattish earnings profile for FY23 as the most likely scenario, with a return to high-teens ROE unlikely until FY24 - in essence, the bank won't be delivering excess returns to its cost of equity anytime soon, making it hard to justify a ~1x P/Book valuation here.

Cleaning Out the Closet

Coming off one of its worst quarters on record, Bradesco may not be out of the woods just yet. Americanas was the key overhang this time around (Bradesco had the highest exposure out of the major Brazilian banks), and while management has made 100% provisions this quarter, there could still be some lingering effects for the next few quarters.

The key disappointment, though, was the guidance, which now implies a low-teens % ROE for FY23. Not only will the bank likely be earning below its cost of capital this year, but with inflation and a rate-driven slowdown set to hit Bradesco's key lower-income customer base the hardest, it's hard to see the bank's earnings power recovering anytime soon. Over the mid to long term, this is still a mid- to high-teens ROE banking franchise, in my view, but with more negative than positive catalysts on the horizon, it's hard to justify buying Bradesco stock at this juncture.

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