DNSKF - Danske Bank: A Quality European Bank The Discount Is No Longer Warranted

2023-11-09 02:51:36 ET

Summary

• Danske Bank's valuation is cheap compared to its Nordic peers, but the discount is no longer warranted due to fixed issues.
• The bank's net interest income has been a major growth driver, but it may peak in 2023 as interest rates decline.
• Danske Bank's strong capital position supports an attractive shareholder remuneration policy, including dividend payments and share buybacks.

Danske Bank A/S (DNSKF) is one of the best banks in Europe and its valuation is quite cheap compared to its Nordic peers.

As I’ve covered in a previous article , Danske's valuation is at a discount compared to its closest peers, mainly due to past issues regarding anti-money laundering controls.

With this issue fixed and the recent resumption of its dividend, Danske’s valuation discount to peers should narrow, as the discount is no longer warranted in my opinion. In this article, I analyze its most recent earnings and update Danske’s investment case, to see if it offers value for long-term investors right now.

Earnings Analysis

Danske Bank is mainly focused on retail and commercial banking across Nordic countries, being the market leader in its domestic market. This means its business is somewhat geared to interest rates, which has been a key tailwind for higher revenue and earnings growth in recent quarters.

Nevertheless, due to the low interest rate environment that was present for many years, Danske pushed for fee-based products in the recent past and nowadays is not among the European banks with more exposure to rates. Indeed, in the last year, its net interest income ((NII)) accounted for some 55% of total revenues, while other European banks more geared to rates have a NII contribution to revenues in the 75%-80% range.

Due to rising rates, its NII contribution has risen in recent quarters and has been its major growth driver. In 9M 2023 , its NII increased by 46% YoY to $3.7 billion, supported by expanding margins as the cost of deposits didn’t increase much. On the other hand, fees and commissions dropped by 10% YoY to $1.2 billion, while trading income increased considerably to $421 million (vs. $125 million in 9M 2022).

This combination of higher NII and weak fee trends, led to a total weight of NII on total revenues of 67% over the first nine months of 2023, switching somewhat its operating leverage to rates. Its total revenues during this period amounted to $5.5 billion, up by 33% YoY, a trend that should persist at least for the next couple of quarters, as rates have probably recently reached a peak in Europe.

Indeed, as can be seen in the next graph, current market estimates regarding interest rates in Denmark are forecasting lower rates ahead, with significant central bank rate cuts expected in the second half of 2024.

This means that, most likely, NII will peak in 2023 and further gains aren’t likely beyond Q4 2023, as inflation is clearly moderating in Europe and the need to maintain relatively high interest rates is expected to decline in the near future. Investors should note that Denmark’s CPI growth rate was only 0.9% YoY in last September, a below-average inflation rate compared to other European countries, thus Denmark’s central bank is not pressured to raise rates and should maintain its strategy of following the European Central Bank’s rate path, due to the currency peg to the Euro.

In other Nordic countries, inflation rates remain at more elevated levels, but the downward trend is the same and the pressure to maintain high rates should ease in the coming months, probably leading to lower NII in these countries as well over the coming quarters.

Regarding expenses, despite the inflationary environment the bank was able to report a decrease of 4% YoY in 9M 2023 to nearly $2.7 billion, due to a lower number of staff, leading to a cost-to-income ratio of 49%. This is an acceptable ratio, but further improvements in the coming quarters must come from cost cutting given that revenue growth is expected to be much more muted, thus I don’t expect Danske’s cost-to-income ratio to change much in the short to medium term.

Regarding credit quality, its loan impairment charges amounted to only $42 million in 9M 2023, versus $113 million in the same period of 2022, showing that Danske’s credit quality remains quite good and loan losses remain at historically low levels.

Due to this combination of higher revenues, and lower costs and provisions, Danske’s net income more than doubled compared to the previous year, reporting a profit of $2.2 billion in the first nine months of 2023. Its return on equity ((ROE)) ratio, a key measure of profitability in the banking sector, was 12.5% in this period, its highest level over the past five years.

For the full year, Danske expects its net income to be around $2.85 billion, which represents an annual increase of 43% compared to its 2022 adjusted earnings, excluding the negative impact of its settlement related to the AML issue.

Regarding its capital position, Danske is one of Europe’s best capitalized banks measured by its CET1 ratio of 18.8% at the end of September. This is much higher than the average of the European banking sector, at about 14%, and also way above its own capital requirements (14.3%) and internal target (above 16%), being a strong support for an attractive shareholder remuneration policy over the next few years.

As the bank does not need to retain much earnings, it can easily distribute a large part of its profits, both through dividends and share buybacks. Its dividend policy is to distribute 40-60% of annual earnings through dividends, while share buybacks will depend on market conditions.

After some uncertainty about its capital return policy due to the settlement of past AML issues, Danske has returned to dividend payments last July and wants to maintain a regular distribution over the next few years.

Its last dividend was $1 per share, related to 2022 earnings, which at its current share price leads to a dividend yield of about 4.2%.

While this is an interesting yield, its dividend is expected to increase greatly next year related to 2023 earnings. Investors should note that Danske’s dividend frequency is annual, thus Danske is expected to announce its annual dividend together with its annual earnings presentation, probably in February or March 2024. Current street estimates expect Danske to double its dividend to about $2 per share, which means its dividend yield is expected to double, making it a high-dividend yielder. In the following years, Danske is expected to grow its dividend by mid-single digits, which seems reasonable as the bank has a strong capital position and should report strong earnings over the next few years.

Conclusion

Danske is one of the best banks in Europe due to its exposure across the Nordic markets, leading to low levels of credit losses and above-average profitability over the economic cycle. Its most recent earnings show that its operating performance has improved considerably and is now in a strong position to become a high-dividend yielder, in a sustainable way.

Despite this profile, its shares remain attractively priced given that Danske is currently trading at 0.84x book value, in-line with the European banking sector, but at a discount to its Nordic peers, which trade on average at 1.04x book value. A reason why Danske trades at a discount is its smaller yield (4.2% vs. 7.8% of its peer group), a situation that is expected to ‘normalize’ in the coming months, being potentially a positive catalyst for a re-rating of its shares.

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