Summary
- European financials should benefit from ECB rate normalization.
- EUFN weighted EPS could grow 20% in 2023.
- While valuation is still low at 5.9x PE and .9x P/BV.
Summary
iShares MSCI Europe Financials Sector Index ETF ( EUFN ) holds European financial stock (Banks, Insurance, Asset Managers and Exchanges) that are interest rate sensitive and should benefit from what I consider rate normalization by the ECB. My analysis focused on the top 20 holdings that make up 63% of the ETF assets that point to 20% ESP growth vs a 5.9x PE, far lower than the SP500-40 S&P 500 Financials Index Sector ( SP500-40 ). This sector has grossly underperformed in the last 13yrs on very low and even negative interest rates that are rising rapidly, the ECB indicated a 2.9% target rate in 2023.
Structure and Performance
EUFN has 88 holdings with about 53% weighted in Banks and 32% in Insurance companies. The top 20 holding equal 62% of the fund with HSBC the largest at 8.5% while UK listed institutions are 25%. The ETFs performance has been poor, down 9% since inception in Feb 2010 while the SP500 Financial sector was up 204%. However, from pandemic lows it up 40% and from Oct 2022 lows it up 27%.
Bottom Analysis
I analyzed the top 20 holdings to gauge the growth and valuation potential of the ETF. Using consensus estimates and weighting the results, I arrive at an attractive 20% EPS growth forecast for 2023 while valuation looks inexpensive at 5.9x. The unweighted averages are higher, and it may be useful to scan for the most attractive stocks in the fund if one can access those markets.
On a relative bases, the ETF looks to have growth and valuation metrics substantially better than the SP500 Financial index.
NIM vs. ECB
In addition to the consensus estimates, I also looked at the historical relation between NIM (Net Interest Margin) for banks and the return on portfolio for insurance companies' vs the ECB rates. There seems to be a good correlation and if the ECB continues to raise rates and hold them as a new normal, the sector may re-rate as earnings and ROE improve.
For Banks, there is a NIM lag, as deposit rates are shorter maturity and increase before new loans are priced up. In 2023, the sector should see absolute spread gains, perhaps by 50 to 100 basis points, which may appear modest but are a 25% to 50% increase. Higher NIM generates greater revenue that more than offsets potential non-performing loan losses and operating costs. In addition, if the EU and UK can escape a recession, there may be more EPS upside.
Insurance companies have been impacted by a decline in investment results as bond and equity portfolios declined on higher rates, etc. Going forward, the higher yields should produce substantially better long term results and drive up ROE.
Conclusion
I find the EUFN ETF useful in gaining exposure to a diversified portfolio of European interest rate sensitive stocks that appear to have low valuation and strong EPS growth as the ECB normalizes the interest rate structure in place since the GFC of 2008/09.
For further details see:
EUFN ETF: Monetizing Higher European Interest Rates