KBCSY - KBC Group: One Of The Best European Banks Offers A High-Dividend Yield

2023-04-12 16:43:38 ET

Summary

• KBC is a retail-oriented bank with a strong exposure to concentrated markets of Belgium and Czech Republic.
• It has very strong fundamentals within the European banking sector.
• KBC offers a high-dividend yield and is attractively valued.

KBC Group ( KBCSY ) is one of the strongest banks in Europe and has very good capital return prospects ahead, being a great income play right now within the European banking sector.

Company Overview

KBC is a Belgium bank focused on the retail and commercial banking segments, plus insurance, other banking services, and asset management. It has a market value of about $29 billion and trades in the U.S. on the over-the-counter (OTC) market.

The bank is one of the few remaining European banks following a bancassurance business model, which means it considers both banking and insurance as core business segments. Before the global financial crisis of 2008-09 there were more Benelux banks following this business model, but state bailouts and subsequent restructuring programs led to a separation of banking and insurance activities for most groups. This business approach is also popular in France, while in the rest of Europe the bancassurance model is not the usual approach.

The key benefit of this business approach is a better capacity to cross-sell a larger number of financial products and services to its customers, instead of partnering with other insurance companies and acting solely as a product distributor. About 80% of its net profit comes from retail banking, while the rest is mainly generated from insurance operations.

Geographically, KBC is largely exposed to its domestic market and Czech Republic, being its two largest markets, while it also has a presence in other smaller countries, such as Hungary, Slovakia, and Bulgaria. It also had operations in Ireland, which the bank recently sold to Bank of Ireland Group ( BKRIY ), streamlining KBC's business profile in countries where it has higher market shares.

Business Strategy

KBC's strategy has not changed much over the past few years and is not expected to be much different in the near future. Its business model has been focused on retail operations in Belgium and Czech Republic, two markets that have a higher banking concentration than average, being a positive backdrop for established players.

This means that competition is relatively low when compared to more fragmented markets, providing higher profitability levels that are sustainable over the long term. Moreover, these markets have historically seen good credit quality, providing a very favorable operating background for KBC.

Indeed, KBC's unique exposure to these two very attractive banking markets in Europe is a key competitive advantage over the long term, being a business profile that is not easy to replicate within the European banking sector.

This explains why KBC's return on equity (ROE) ratio, a key measure of profitability within the banking sector, has on average been much higher than the vast majority of its peers since 2014, showing that it has a quality business profile in the European banking sector.

While KBC's business model is not expected to change much going forward, the bank is adapting its operations to the current banking environment, namely investing considerably in digitalization to offer a better customer service and reduce costs. Regarding acquisitions, KBC doesn't intend to enter into new markets, but can make small bolt-on acquisitions in its current geographies to increase its market share and generate synergies with its current operations, both on the banking and insurance segments.

Financial Overview

Regarding its financial performance, KBC has a very good track record considering that it has delivered above-average profitability over the past few years, and has reported strong growth in recent quarters supported by the rising interest rate environment in Europe.

In 2022 , its revenues increased by 14% YoY, boosted by net interest income which rose by 16% YoY to more than €5.1 billion in the year, supported by higher interest rates and volumes across its business units, leading to a loan book of €186 billion at the end of the year (+8% YoY). Its net interest margin increased to 1.96% in 2022 (vs. 1.81% in the previous year), supported by higher asset yields while the cost of deposits and other liabilities was relatively stable.

On the other hand, fees and commissions were up by only 1% YoY, pressured by lower assets under management in its asset management unit. In the insurance segment, both Life and Non-Life segments performed well and reported positive sales growth, while trading results also increased last year.

On the cost side, its operating expenses increased by 10% YoY to about €4.8 billion, due to wage inflation and other rising expenses. As revenue growth was higher than cost growth, KBC was able to improve efficiency, as measured by its cost-to-income ratio of 48% (vs. 51% in 2021).

Regarding credit quality, it remained at very good levels, considering that its cost of risk ratio was only 8 basis points (bps) in 2022. Investors should note that KBC increased provisions in 2020 due to Covid-19, which were not used and led to reversals, to some extent, in 2021. Therefore, KBC's provisioning levels are quite good and the cost of risk should remain at relatively low levels, as credit quality is expected to remain resilient in the short term.

Due to a combination of positive margins and good credit quality, KBC's net income increased by 10% YoY to €2.86 billion in 2022, while its ROE was 14%. This profitability level is among the best in Europe, showing that KBC has stronger fundamentals than most of its peers, a profile that is not expected to change over the coming years.

Regarding the bank's guidance for the next few years, the bank expects annual income growth of about 6% from 2022-25, annual cost growth of 1.8%, and a cost of risk ratio between 25-30 bps through the cycle. This means KBC should continue to benefit from rising interest rates and maintain a good cost control in the near term, which is expected to improve its efficiency ratio to about 43% by 2025, while its profitability is expected at very strong levels over the next few years.

Beyond a positive operating performance and high profitability levels, another strong factor of KBC's business profile is its above-average capitalization. Indeed, at the end of 2022, its CET1 ratio was 15.4%, comfortably above its capital requirement and slightly ahead management's internal target of 15%.

Moreover, due to its recent disposal of its Irish business, KBC excess capital position will be increased, leaving plenty of room to distribute excess capital to shareholders.

Taking into account this background, it's no surprise that KBC's dividend policy is to distribute at least 50% of annual profit to shareholders (considering dividends plus AT1 coupons), with further special dividends or share buybacks decided discretionarily when the capital ratio surpasses its internal target.

Its policy is to distribute an interim dividend of €1 per share in November, plus a final dividend that is adjusted based on its annual earnings. Related to 2022 earnings, KBC's total dividend was set at €4 per share, which at its current share price leads to a dividend yield of about 6.25%.

While this dividend is already quite attractive, it is likely that KBC will distribute a special dividend in the coming months financed from proceeds of the Ireland disposal, plus the bank is also likely to perform share buybacks, or a combination of the two. A decision is expected in the next few months, which is likely to have a positive impact on its share price.

Going forward, the bank is expected to deliver a growing dividend over the next few years, given that according to analysts' estimates , its dividend is expected to be €5.45 per share by 2025, enhancing even further its income appeal in the near future.

Conclusion

KBC is one of the best banks in Europe, due to its high exposure to attractive markets, leading to a strong profitability level that is sustainable over the long term. On top of that, it also has a superior capitalization and high-dividend yield, making it a great income investment within the European banking sector. While a quality bank like KBC almost always trades at a premium to its peers, recent weakness in the banking sector led to a valuation close to its historical average (about 1.4x book value), therefore providing a good entry point for long-term investors.

For further details see: