BWAGF - Erste Group Bank: Unfulfilled Eastern Promises

Summary

• Erste Group Bank reported strong results for 2022.
• Guidance for 2023 was cautious but optimistic.
• Nevertheless, it is unlikely that shares will be able to break out of a trading range between 15 and 40 euros, where they have been stuck for more than a decade.
• New investors should wait for a better entry point as shares currently trade at the upper end of that range.

(Note: all amounts in the article are in EUR. At the current exchange rate this is almost equivalent to USD.)

Thesis

Erste Group Bank (EBKDY) (EBKOF) is a quality European bank with a clear focus on Central and Eastern Europe. The bank reported strong results for 2022 and guidance for 2023 was cautious, but optimistic. The market rewarded the good results and the optimistic guidance with a share price increase of almost 5% on the day of the announcement.

The stock is still trading at a relatively low valuation, but not significantly lower than its European peers.

Shares are up 67% since their low point in August 2022 and up 20% YTD. They are close to the upper end of a range between 15 and 40 euro where the stock has been for trading for more than a decade now. To me it looks more likely that this pattern will hold again, and the stock will not be able to break out. Therefore, I see a limited positive runway for Erste Group.

Company Overview

There are already several articles on Seeking Alpha describing Erste Group Bank and its business model. I do not think I can provide much value by repeating that. I want to give a personal view, though.

I wrote my very first article on Seeking Alpha last year on another Austrian bank, Raiffeisen Bank International (RAIFF) (RAIFY). A user messaged me and asked what I think about Erste Bank. The bank announced the 2022 results on February 28, and I thought it was a good point in time to write down my thoughts.

Erste Group Bank is a financial services provider headquartered in Vienna, and a true Austrian institution - in the sense that it has always been around. Erste Bank was founded in 1819 (!) as the first Austrian savings bank.

I became a customer of the bank when I was in primary school. I was around 8 years old when a savings bank representative visited the school. I do not remember much except that he explained the importance of saving money (the bank uses a bee as its trademark!), and that everybody got a savings book and became a customer. At that time, there were so called anonymous savings books in Austria, and they were quite popular. Deposits and withdrawals were recorded in the book, and anybody who had the physical savings book could get the money. Anti-money-laundering was not such a big thing then.

The first 180 years were quite slow for the bank. After several acquisitions and mergers in Austria, Erste Bank had reached a certain size and went public in 1997. Around that time, the bank also started to expand into Central and Eastern Europe. It made bold moves, given its small size at the time, and acquired large financial institutions across the region. Erste Bank Group has grown to become one of the largest financial services providers in the Eastern part of the EU in terms of clients and total assets. On a map the bank looks remarkably like the old Habsburg empire, and - thinking of the management in those years - this is maybe even by intention:

Accordingly, it should be noted that the bank has no direct exposure to Ukraine, Belarus and Russia.

Shares have been disappointing for long-term investors over the last decade

For investors, at least the long-term variety, this has not really paid off though. After the IPO the shares price continuously appreciated, as acquisitions in Eastern Europe developed well and countries joined the European Union. But the 2007/2008 financial crisis put an end to this, and after 2008 the stock has moved up and down in a range between around 15 to 40 euro:

But that does not mean that there is no opportunity here. I have been buying and selling Erste Bank several times over the last years. My approach is to buy in a range of 20-25 euros and sell at 35-40. The exact numbers depend on how I see the overall market at a specific point in time. While not perfect, this has worked reasonably well for me in the past.

I consider the market to be overbought now and see the risk of a correction coming over the next months. The Austrian stock index ATX ( ATX:IND ) is up 30% since September last year and Erste Bank is up more than 50%. Accordingly, I have sold recently.

If I am right (again), the bank stock has not much of a runway in front of it.

For what it is worth, according to MarketScreener , the average target price from analysts is 42 euro, with a low of 32 and a high of 52. So, this is not much help.

2022 financial results

In line with other European banks, Erste Bank Group had a strong year. Economies in Central and Eastern Europe have proven to be more resilient than many assumed.

Good demand for credit and rising interest rates across all markets helped to increase net profit to 2.16bn, after 1.92bn in 2021 (+12.5%).

Net interest income increased to 5.95bn, up 19.6% YoY. Clearly the bank's strong deposit base has been an advantage in the rising interest environment.

Net commission income also increased by 6.5% to 2.45bn. Main drivers were payment services and asset management.

Despite the inflationary environment, the cost increase was lower than the increase in income. Accordingly, the cost/income ratio improved from 55.6% to 53.4%. Erste Bank has seen a continuous improvement here, meaning it has become more profitable and efficient over the last years.. In 2020 the C/I ratio was still at 59%, and even 60+% previously. Cost discipline used to be not one of the strong suits of the bank, but this has improved, although I think they should do more here. Erste Group is still behind best-in-class competitors like its Austrian peer BAWAG Group (BWAGF), who managed to reduce its cost base in absolute numbers in 2022, despite the inflationary environment. BAWAG Group has a C/I ratio of 35.7%.

Return on Tangible Equity was 13.8%, up 110pp YoY. ROTE had been 15.2% though in 2018, so this is not a record for the bank.

Capital position

The CET1 ratio was in a very safe place at 14.2%, though down 30pp from 14.5% in 2021.

The bank defines excess capital as the capital portion above 14.0%. The regulatory minimum ratio including Pillar 2 Guidance for YE 2023 is 12.03%. So, the bank is conservative here.

Risk cost

Risk cost in 2022 was a low 15bps over the year, with some quarter-to-quarter fluctuations:

NPL ratio was 2.0% at the end of the year, down 40pp from 2.4% YoY. This is a historic low for the bank. Also, no market had a NPL ratio higher than 2.8% (Hungary and Romania were at 2.8%).

The only (small) red flag here is that stage 2 loans increased to 19% from 17% at the end of 2022. The bank says that most stage migrations are driven by FLI (forward looking information) updates due to portfolio and energy cost overlays. I am not worried about this.

2023 guidance

Guidance for 2023 was relatively optimistic, which surprised me. In December last year the bank put a Factsheet document on its website which includes a remarkable statement from the CEO. The statement is short (it has only 105 words, I counted them), but mentions "Challenge" or "challenging" five times. I don't know if he really means it, or his people just forgot to proofread the statement. He was Chief Risk Officer before he became CEO, so maybe he means it.

In general Erste Group expects growth to continue in 2023 but to slow down. As the CEO says, times are challenging, so there is a litany of macroeconomic conditions behind the growth assumptions.

The bank expects net loan growth in the mid-single digits, and an increase in net interest income of approximately 10%. This is lower than the 19% growth in 2022, but still significant. Net commission income is expected to increase by around 5%, which is only slightly lower than the 6.5% in 2022.

While cost inflation in 2022 was at 6.2%, the bank expects an updrift in 2023 at 7-8%.

Operating result and the cost/income ratio are projected to improve, and the bank aims for a ROTE between 13 and 15%. ROTE in 2022 was 13.8%.

The bank expects risk costs to remain at the same low level as in 2023 and be below 35bps.

Valuation

EPS for 2022 was 4.83 euro. At the current share price of 37 euro, the P/E ratio is 7.67. This is cheap, but not significantly cheaper than other European peers.

The same goes for the P/B ratio, which stands at approximately 0.8 . You can find European peers with a lower P/B ratio, but I think 0.8 is in line with the 13.2% ROTE.

Erste Bank plans to pay a dividend of 1.90 euro for the fiscal year 2022. The dividend for 2021 was 1.60, so this a substantial increase. The increase results in a respectable, but not outstanding 5.5% dividend yield. (Non-Austrian investors should also keep in mind that Austria has a dividend withholding tax of 27.5%.)

The bank also announced that it plans to buy back approximately 2% of shares outstanding in 2023. Still, the total shareholder reward of 7.5% is not huge.

Conclusion

Erste Bank Group is a quality European bank with a clear focus on Central and Eastern Europe. The bank is trading at a relatively low valuation, but not significantly lower than its peers. The share price is currently close to the upper end of a range between 15 and 40 euro where the stock has been trading for more than a decade now. Given market conditions, to me it looks like this pattern will hold again, and the stock will not break out of the range.

If I am right, new investors should wait for a better entry point.

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