UNCRY - UniCredit Is Moving In The Right Direction

2023-12-01 03:42:50 ET

Summary

• There is a potential upside from inorganic acquisitions and on potential capital distributions.
• UniCredit purchased almost 9% of Alpha Services share capital. The Italian extra profit tax was moved to a reserve.
• Large tangible book value discount compared to UniCredit prospective returns.

After analyzing Intesa Sanpaolo , we are back to commenting on the second Italian bank by market capitalization, UniCredit ( OTCPK: UNCFF , OTCPK: UNCRY ). Since mid-September, UniCredit's stock price has grown more than 20%, exceeding our target price. In the report, we emphasize how UniCredit was Likely To Deliver Long-Term Returns throughout the economic cycle, and we also report our positive view on the bank's cost-competitive advantages and lower Non-Perfoming Loans (NPL) and Unlikely To Pay (UTP) evolution. Today, post Q3 results, as we performed for Intesa Sanpaolo, we decided to increase the company's target price and update our readers on UniCredit's latest acquisitions (Alpha Services) and developments (extra profit tax and Signa real estate exposure).

Positive Update

( Inorganic acquisitions ) UniCredit recently purchased 8.9781% of the share capital of Alpha Services and Holdings S.A from the Greek state. The total price per share was €1.39 for a total value of approximately €300 million. According to our estimates, this implies circa ten basis points on the CET1 ratio. This minority acquisition is part of the long-term partnership to develop UniCredit presence in Greece and Romania. Looking ahead, UniCredit plans to merge its Romania assets with Alpha Bank. This transaction will create the third bank by total assets in the respective local market, with a market share of 12%. UniCredit will strengthen its presence in countries with high growth potential and have the ability to sell its platform and products in Greece, another country with strong growth prospects supported by trade and tourism. According to UniCredit, the bank will benefit from more than €100 million of incremental net profit when fully operational. Another area with strong attention remains the payment companies. The bank is looking for an industrial partner, and Nexi could be the right partner. Here at the Lab, we will positively view this transaction.

( From Achilles' Heel to Zeus's Shield ) Here at the Lab, we already commented on the Italian windfall taxes on bank profits. However, Unicredit has set aside €1.1 billion as a reserve. On the topic, Italian law gives two options : pay the tax or strengthen the bank reserves. UniCredit chose the second and most reasonable solution, consistent with the bank's capital allocation priority.

( Signa Real Estate update ) Looking at Signa's recent development , according to Reuters, Unicredit would be exposed for around €600 million through Hypovereinsbank. UniCredit declined to comment, but here at the Lab, we believe that the bank has not financed the holding structure but Signa's development projects. Therefore, the bank exposure would be highly collateralized. Consequently, we apply no changes in the group's guidance revision. In addition, UniCredit declined to comment.

Changes in Estimates

1. UniCredit closed the Q3 results with revenue and profits above Wall Street expectations (and our internal estimates). According to the numbers collected by the bank, revenue and profits were expected at €5.74 and €1.92 billion, and UniCredit achieved a quarterly performance of €5.96 and €2.32 billion (Fig 1);
2. Following Q2, Q3's interest margin is still growing by 3%, and the bank continues to benefit from higher interest rates and the increase in commercial spread. In detail, this positive evolution fully offsets the negative volume of loan growth. Here at the Lab, with volumes drifting slowly again, we estimated a 2% loan decline on a quarter-to-quarter basis, with UniCredit margins that remain the main driver;
3. In 9 months, UniCredit's net profit reached the record figure of €6.7 billion, with an increase of 67.7% year on year; however, what is remarkable is the evolution of operating costs. In number, the bank reached an expense of €2.32 billion with a cost/income ratio of 39% vs. a year earlier at 49.4% (Fig 1);
4. The CET 1 ratio reached 17.19% vs. consensus estimates of 16.89%, and the bank is now one of the more capitalized companies within our EU banking coverage. This protects the bank in future uncertain times. On a negative note, we should also report that the company increased its Stage 2 loans due to a reclassification of €5 billion of Russian loans (Fig 2). Considering the latest acquisition and a solid cash generation in Q4, we guide a CET 1 ratio at 18% by year-end;
5. The bank cost of risk reached 12 basis points, and for the above reason, the company (once again) improved its 2023 financial guidance (Fig 3). Net interest income is guided by at least €13.7 billion (the previous outlook was set at €13.2 billion), translating into net revenues exceeding €22.2 billion. UniCredit's net profit guidance is confirmed at above €7.25 billion, with the bank intending to maintain a similar profitability level in 2024. Together with a higher Euribor, this will likely drive earnings in 2024 and suggests an upside to consensus estimates for 2024. In numbers, we decided to increase our year-end estimates with net earnings at €7.5 billion; however, considering a lower cost/income evolution, our 2024 and 2025 earnings projections are set at €6.3 and €6.2 billion. In our three-year visible period, UniCredit will likely have an ROE higher than 10% with cash optionality for acquisitions or particular distribution;
6. Regarding capital distribution, the CEO noted a balance between buybacks and cash dividends. UniCredit is likely to pay a payout above the 35% level. Therefore, based on our estimates, we predict a yield (buyback and dividend) of at least 7% for 2024 and 2025. This increases our capital distribution to at least €6.5 billion from €5.75 billion. Related to the 2023 performance, in today's Bloomberg TV comment , UniCredit CEO envisaged a very generous shareholder remuneration plan, distributing at least €6.5 billion, representing a current yield of 15%.

Source: UniCredit Q3 results presentation - Fig 1

Fig 2

Fig 3

Conclusion and Valuation

With guidance upped again, UniCredit is now expecting net profit in excess in 2023, but it has also raised the bar for the upcoming years thanks to better net interest income and lower cost of risk <25 basis points vs. 30-35 basis points. This suggests a higher capital distribution and earnings power sustainability across the cycle. This latest trend supports our pre-results view. Therefore, today, as we performed for Intesa Sanpaolo, we decided to increase the UniCredit target price from €24 to €29.9 per share, hence prolonging our outperformance rating. Valuing UniCredit with a 7x P/E, in line with Intesa Sanpaolo, we reached a valuation of €31.5 per share. Despite that, we decided to apply a blended valuation methodology using also the 0.9x price-to-book value (in line with KBC Group and BNP Paribas ). Accounting for the TBV estimates, we arrived at €28.35 per share. Therefore, UniCredit trades at a significant discount vs its prospective returns (RoTE above 10%). Averaging the two valuation methodologies, we arrived at a value of €29.9 per share. Our buy is then confirmed.

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