CRZBF - Commerzbank: Poised For Bullish 2023

Summary

• Commerzbank announced EUR1.4 billion of profits for FY 2022, more than triple the profitability of 2021.
• Notably, Commerzbank's strong FY 2022 performance was supported by both topline expansion and cost improvement.
• Commerzbank's management voiced confidence going into 2023, expecting that a favorable NIM will push profitability even higher.
• I estimate that, in FY 2023, Commerzbank could likely accumulate between EUR2 billion-EUR2.5 billion of net profits.
• I anchor my Commerzbank valuation on a residual earnings model, and I calculate a fair implied share price for CRZBF of $16.70.

Thesis

Commerzbank ( CRZBF ) has closed FY 2022 accumulating EUR1.4 billion of net income. And although the German credit institute continues to operate in a challenging macro environment, Commerzbank management voiced confidence going into 2023 - expecting that a favorable NIM will push profitability even higher. Moreover, the bank's management team promised to investors a payout ratio of 50%, which could likely support an equity yield of close to 10%.

Reflecting on a favorable interest rate tailwind, Commerzbank stock looks undervalued. I anchor my valuation for the bank on a residual earnings model, and I calculate a fair implied share price for CRZBF of $16.70.

For reference, after a decade of enormous underperformance...

Commerzbank's stock has finally started to show relative strength. For the trailing twelve months, Commerzbank stock is up approximately 25%, as compared to a loss of close to 9% for the S&P 500 ( SPY ).

Strong Interest Rate Tailwind Supports Exceptional FY 2022 Profitability

Commerzbank closed FY 2022 with strong Q4 results, comfortably beating analyst consensus estimates with regard to both topline and earnings. During the period from September to the end of December, Germany's second-largest bank generated total revenues of EUR2.4 billion, which compares to EUR2.1 billion for the same period one year prior (a 14% year-over-year growth). Moreover, the bank's operating result more than tripled: jumping from EUR141 million in Q4 2021 to EUR528 million in Q4 2022.

For FY 2022, revenues grew to EUR9.5 billion, reflecting a 12% year-over-year expansion as compared to EUR8.5 billion in FY 2021. The bank's operating profit jumped from EUR1.2 billion to EUR2.1 billion, a 75% year-over-year expansion respectively.

Notably, Commerzbank's strong FY 2022 performance was supported by both topline expansion and cost improvement: First, and most notably, the bank took advantage of a strong interest rate environment, which supported approximately 12% of YoY revenue growth. Second, complementing the higher topline, management also managed to decrease costs by about 300 basis points, with total costs falling from EUR6.7 billion in FY 2021 to EUR6.5 billion in FY 2022.

Anchored on strong FY 2022 results, Commerzbank management announced EUR250 million of dividends and buybacks of about EUR122 million.

Poised For A Bullish 2023

In the post-Q4 conference call with analysts, the bank's CFO Bettina Orlopp commented :

the trajectory of NII in 2022 has been impressive , driven by higher central bank rates, which helped the deposit businesses. For the whole year, it has been 36% above 2021 . In Q4, the increase in underlying NII was particularly pronounced as there were several euro rate hikes, while the deposit better was still very low and the contribution from the loan business largely stable.

And anchored on the prospects of further rate increases, Orlopp estimated that 2023 profitability will likely "go much beyond the €1.4 billion euros (achieved in 2022)". According to management expectations, 2023 NII will likely expand to EUR6.5, with a potential upside opportunity of EUR7.1 billion.

Commerzbank's estimates are in line with my personal model: as compared to 2021 numbers, my model - which anchors on management commentary from Deutsche Bank, Barclays, UniCredit, and Société Générale - calculates that for every 1 percentage point of interest rate increase, European banks are likely to enjoy a 20 basis point increase in NIM expansion.

Considering that the ECB is committed to raising the marginal lending facility rate to 4 percentage points in 2023, I estimate that in the coming 12 months, Commerzbank could likely accumulate between EUR2 billion-EUR2.5 billion of net profits. That said, reflecting on a 2023 net result well above 2022, paired with a pay-out ratio of 50%, Commerzbank investors will likely enjoy a 2023 equity yield of close to 10%.

Valuation: $16.70/Share Target Price

In my opinion, banks are prime candidates to be valued with a residual earnings valuation, given that the RE framework anchors on both the income statement and the balance sheet as well as accrual accounting. As per the CFA Institute :

Conceptually, residual income is net income less a charge (deduction) for common shareholders' opportunity cost in generating net income. It is the residual or remaining income after considering the costs of all of a company's capital.

I apply the following assumptions:

• To forecast EPS, I anchor on consensus analyst forecast as available on the Bloomberg Terminal 'till 2025. In my opinion, any estimate beyond 2025 is too speculative to include in a valuation framework - especially for banks.
• To estimate the cost of capital, I use the WACC framework. I model a three-year regression against the DAX 40 to find the stock's beta. For the risk-free rate, I used the U.S. 10-year treasury yield as of February 17, 2022. My calculation indicates a fair required return of 10.75%.
• For the terminal growth rate, I apply 2% percentage points, slightly below the estimated nominal GDP growth in order to reflect a conservative valuation.

Based on the above assumptions, my calculation returns a base-case target price for Commerzbank of $16.70/share, implying a material upside of close to 40%.

I understand that investors might have different assumptions with regard to Commerzbank's required return and terminal business growth. Thus, I also enclose a sensitivity table to test varying assumptions. For reference, red-cells imply an overvaluation as compared to the current market price, and green-cells imply an undervaluation.

Without a financial market meltdown, the picture looks very favorable to me.

Risks

I think bank investments are safer than the market suggests, but there is still elevated tail risk that could, in very extreme cases of financial distress, bring Commerzbank close to bankruptcy. Banking is a risky business, as many big financial institutions have not yet recovered pre-financial crisis levels. However, Commerzbank's 14.1% CET1 ratio should protect the company in most stressful scenarios.

Conclusion

Commerzbank announced EUR1.4 billion of net profits for FY 2022, more than triple the profitability of 2021. Notably, Commerzbank's strong FY 2022 performance was supported by both topline expansion and cost improvement. Moreover, Commerzbank management voiced confidence going into 2023, expecting that a favorable NIM will push profitability even higher.

I estimate that in FY 2023, Commerzbank could likely accumulate between EUR2 billion-EUR2.5 billion of net profits. That said, I anchor my Commerzbank valuation on a residual earnings model, and I calculate a fair implied share price for CRZBF of $16.70.

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