2023-09-07 00:12:27 ET
Summary
- EUFN is monetizing the ECB rate hikes; EPS may grow 22.5% in YE23.
- iShares MSCI Europe Financials ETF has outperformed the US peers by 22% LTM.
- EUFN portfolio valued at 7.2x PE with potential for 19% price gains and 5% dividend yield.
Overview
I initially invested in iShares MSCI Europe Financials ETF (EUFN) ( see article ) in January of this year on the premise that the ECB (European Central Bank) would continue to hike rates and benefit most financial institutions across Europe after more than a decade of 0% to negative rates. This ETF provides access to many stocks not listed in the US or not officially sponsored (OTC).
While the sector did not escape contagion from the US Regional banking crises, it has recovered faster and produced a solid outperformance (22% vs 0% XLF ) that is expected to continue into YE24.
EUFN vs US Financials LTM (Created by author with data from Capital IQ)
EUFN has 83 holdings with 80% of the fund concentrated in 38 names. HSBC ( HSBC ) is the largest with 8.5% followed by Allianz ( ALIZF ) (5.6%) and UBS (UBS) (5%). The fund was launched in 2010 and has US$1.4bn in AUM. Needless to say it has underperformed the US Bank sector, since inception, gaining 27% vs the XLF (+140%).
The ETF portfolio, on YE24 consensus estimates, is valued at 7.2x PE with 5% EPS growth and 16.5% ROE driving potential total return of 24% (19% price gains with a 5% dividend yield).
In my view, the combination of an undemanding valuation, high ROE, conservative EPS growth and increasing shareholder payout, makes this ETF more appealing than the US financial sector.
Key Risk are a deeper than envisioned recession, entrenched inflation that requires ECB rate hikes above 6% and windfall profit taxes that sap EPS and dividends.
Looking Under The Hood
To better assess the medium and long-term outlook of the ETF I conducted a bottom-up analysis on 80% of the portfolio or 38 of the 83 stocks it holds. Using consensus estimates I calculated upside potential, EPS growth, ROE, ROA, Dividend Yield and P/BV.
The first analysis is on the potential upside of the portfolio using consensus price targets' that are generally a 12-month view or to year-end 2024.
The ETF has a 19% 12-month upside based on consensus price targets. The average, if all stocks had equal weight, is 25%. This means it's a relatively well balanced portfolio in terms of upside potential.
EUFN Bottom Up Consensus Price Target (Created by author with data from Capital IQ)
Expanding ROE
The ECB rate hikes have had a significant impact on ROE with earnings ((EPS)) estimated to increase 22.5% in YE23 driving an increase of ROE to 15.3% from 11.6% in YE22. This has provided the banks with excess liquidity i.e. more capital than loan growth which in turn is paid out to shareholders.
Dividend and Share Buy Backs
In terms of dividends, this ETF may produce a 5% yield, which is above most European government bonds. Outliers are HSBC, Intesa (ISNPY) and Legal & General (LGGNY) with yields above 10%. These estimates generally factor in share buy backs.
EUFN Bottom Up Consensus ROE and Div Yld (Created by author with data from Capital IQ)
Medium-Term EPS Growth
Post a banner YE23 the consensus forecast much lower EPS growth, most likely on higher funding/deposit costs and perhaps higher loan losses. All relatively conservative expectations. Thus, the ETF has an estimated 5% and 7.7% EPS growth for YE24 & YE25 respectively. This may seem low but the expanding ROE and dividend payment should support higher share prices, especially if Europe can avoid a deep recession.
Outliers in terms of EPS growth forecast are UBS (post CS acquisition) with a 20% increase in YE24, SocGen ( SCGLY ) (28%), Standard Chartered ( SCBFF ) (19%) and Legal and General (24%).
EUFN Bottom Up consensus EPS Forecast (Created by author with data from Capital IQ)
Undemanding Valuation
The ETF is trading at 7.9x PE YE23 estimates which compares well vs the US Banking sector ( SP500-40 ) at a 15.5x PE and 11.5% ROE. While risks to earnings abound in Europe, the capital base is larger and the sector is more concentrated vs the US, which has, so far, reduced the funding/deposit stress seen at regional banks and increased regulation/capital.
EUFN Bottom Up Consensus PE (Created by author with data from Capital IQ)
SP500-40 Financial Index PE and ROE (Created by author with data from Capital IQ)
Conclusion
EUFN is a diversified portfolio of European financial companies (banking, insurance, asset manager and exchanges) that has and should continue to benefit from interest rate normalization. Its holdings are well-capitalized and regulated, have increasing ROE and excess cash to pay out to shareholders. On Consensus estimates the ETF has 24% total return potential to YE24.
For further details see:
EUFN: 24% Total Return Outlook