SCGLF - Buy Societe Generale For Its Depressed Valuation And 8% Dividend Yield

2023-05-04 16:15:09 ET

Summary

• Societe Generale is one of the largest European banks with a business profile geared to retail and corporate banking.
• Its recent operating performance has been good, while its reported profit in 2022 was affected by its exit from Russia.
• A strong capitalization and positive earnings power lead to a sustainable high-dividend yield and an unwarranted depressed valuation.

Societe Generale ( SCGLF ) is currently undervalued and offers a high-dividend yield, making it an interesting play within the European banking sector.

Company Overview

Societe Generale , commonly known as SocGen, is a French bank, being one of the largest European retail and commercial banks. It operates in several retail markets across Europe, including France, Belgium, and Italy, plus it also has a significant presence in corporate and investment banking, insurance, and specialized lending. Its current market value is about $19 billion and trades in the U.S. on the over-the-counter market.

Its business is divided into three main units, namely retail banking in France, international retail banking and financial services, and global banking and investor solutions. Over the past year, SocGen's global banking and investor solutions was the largest segment measured by revenues (35.9% of total revenue), while international retail operations and financial services generated some 32.5% of revenues, followed by its French retail banking segment that was responsible for about 31.5% of total revenue, showing that the bank has a good business diversification.

Geographically, the vast majority of its revenues are generated in developed markets, even though SocGen also has some exposure to growth markets in Eastern Europe and Africa. Indeed, its exposure to Africa is one of the main distinctive factors of SocGen compared to its peers, where it enjoys good long-term growth prospects due to a lower level of penetration of banking services compared to developed markets. Despite its good diversification, the bank's reliance on its domestic market is still quite significant, given that France represents about half of its total revenues.

Due to its business profile and geographical footprint, SocGen's closest peers are other European banks with a significant presence in both retail and corporate banking, including peers such as BNP Paribas ( BNPZY ), Barclays ( BCS ), Credit Agricole ( CRARY ), or Commerzbank ( CRZBY ).

Financial Overview

Regarding its financial performance, SocGen has reported good results over the past few years, supported by a positive economic environment in its main regions. While there was an uptick on provisions in 2022 related to the pandemic, credit quality has remained quite good and the financial impact on the bank's accounts was modest.

More recently, the bank was able to report strong revenues and earnings due to the rising interest rate environment in Europe, which was more than enough to offset some weaker credit quality due to the economic slowdown, the war in Ukraine, and the bank's exposure to Russia, and rising energy costs in Europe.

In 2022 , its revenues increased to more than €28 billion, up by 8.8% YoY, reaching a new record high and being supported by growth across its three business units. Regarding costs, due to the inflationary environment, the bank reported an increase of 5.9% YoY on operating expenses to €18.6 billion, a smaller growth rate than revenue growth leading to positive jaws.

In the past, one of the bank's main weakest points was its weaker efficiency compared to peers, but this has improved in recent years as the bank has been able to cut costs and now has an efficiency ratio closer to the European banking sector average. Nevertheless, its efficiency ratio was 66.4% in the past year, which is still a higher level compared to the most efficient banks that have ratios between 45-50% (note that a higher ratio is worse), thus SocGen still has more work to do to improve its efficiency in the coming years.

To achieve this, the bank is making some efforts to reduce its business complexity and achieve cost savings, such as the merger of its two retail banking operations in France to a single brand and IT migrations, which should help to cut some costs and improve its efficiency.

However, a weaker efficiency across French banks, SocGen included, is also explained by structural factors, such as restrictive labor laws in France, thus I don't expect the bank to reduce aggressively its operating expenses in the near future and therefore it is likely that its efficiency ratio will remain above 60% for the foreseeable future.

Regarding its credit quality, SocGen has reported much higher provisions in 2022 compared to the previous year, even though its cost of risk ratio is within its over-the-cycle average and remains at relatively low levels. Indeed, SocGen's provisions amounted to more than €1.7 billion in 2022, more than double its provisions booked in the previous year.

This increase in provisions was related to all business units and is explained mainly by macroeconomic issues, reflecting the bank's conservative approach regarding the cost of risk. For 2023, SocGen's guidance is for the cost of risk to be between 30-35 basis points, which means this should be a small headwind to earnings growth in the next few quarters.

SocGen's net profit was impacted last year by the bank's decision to exit Russia following the start of the war in Ukraine, being the European bank that acted more rapidly to address its Russian exposure. SocGen has closed the sale of Rosbank and its insurance operations in the country during Q2 2022, leading to a net loss of €3.2 billion.

This operation markedly impacted SocGen's net income in 2022, which amounted to only €2 billion, while its underlying net income (not accounting for one-off effects) was about €5.6 billion. This means that its reported return on tangible equity (RoTE) ratio of 2.9% does not reflect the bank's earnings power, while its adjusted RoTE of 9.6% is the best measure to reflect its potential profitability in the next few years.

Going forward, SocGen should continue to report a good performance in its top-line supported by rising interest rates in Europe which boost its net interest income, while operating expenses and provisions are expected to rise moderately. According to analysts' estimates , its net profit should be about €3.4 billion in 2023, which seems to be quite conservative considering the bank's underlying profit in the past year, thus there appears to be some room to beat expectations if SocGen's operating momentum remains positive in the coming quarters.

Capital and Dividends

Regarding its capitalization, SocGen had a comfortable capital position, given that its core equity tier 1 (CET1) ratio was 13.5% at the end of 2022, well above its capital requirements and also above the European banking sector average. Moreover, its own internal target is to have a capital ratio above 12% by 2025, which means SocGen has an excess capital position and can therefore distribute a good part of its annual earnings to shareholders.

Given that the bank does not need to retain much cash in the near future, the bank's shareholder remuneration policy is to make capital returns both through dividends and share buybacks. Its total distribution related to 2022 earnings is expected to be about €1.8 billion, which represents close to 90% of its reported profit. While this may seem a high figure, this includes the one-off losses from the disposal of Rosbank in Russia, and thus adjusted for this effect the bank's payout is much lower and clearly sustainable from a recurring operating performance perspective.

Its dividend related to 2022 earnings was set at €1.70 per share, an increase of 3% from the previous year, expected to be paid at the beginning of next June. Investors should note that, like many European companies, SocGen only pays one dividend per year, reducing somewhat its income appeal. On the other hand, at its current share price, SocGen offers a forward dividend yield of more than 8%, which is quite attractive to income investors.

On top of its annual dividend, the bank also approved a share buyback program of €440 million, further enhancing its capital returns policy by about €0.55 per share.

Given that the bank is well capitalized and is expected to remain very profitable in the near future, current expectations are for a growing dividend in the next few years, to a dividend per share of more than €2.20 per share by 2025. This means that SocGen's high-dividend yield is sustainable and is justified by a depressed valuation rather than some structural issues.

Conclusion

Societe Generale has a solid business profile and its operating performance is being supported by a rising interest rate environment in Europe. While the bank still has some factors to improve, such as its efficiency and an average profitability level, its fundamentals and capital position clearly support its high-dividend yield.

Despite this backdrop, its current valuation is quite depressed as the bank is trading at only 0.3x book value, among the cheapest banks in Europe. I see this valuation as unwarranted given the bank's profile, making it an interesting income and value play in the European banking sector right now.

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