With clear signs of macroeconomic improvement in the Euro-zone, I think its time to start looking at its banking sector. European banks are not only the most sensitive sector in the economic cycle but also they trade very cheaply compared to their US peers (there is an average 42% price to tangible book discount to US banks.) On average, European banks sell for 80% of their tangible book value. In some cases, the discount is unfounded. This is the reason why I will propose to you a three-stock portfolio consisting of high-quality European banks.
High-quality and great expected performance
HSBC Holdings plc (ADR) (NYSE:HBC) has a strong capital position that has now been made stronger through asset disposals such as the sale of Ping An for $7.4 billion. In HSBC Holdings plc (ADR) (NYSE:HBC)’s case, there is a huge potential for higher capital returns through dividends and share buy-backs as soon as the group achieves its targeted 10.5% Basel III capital ratio (which is now at 10.1%.) An ameliorated capital position added to more returns for shareholders and an even better profitability level (though cost cutting) make me think that HSBC Holdings plc (ADR) (NYSE:HBC) has a lot to gain going forward. On top of the aforementioned facts, HSBC Holdings plc (ADR) (NYSE:HBC) also offers huge exposure to the growing Asian markets.
Trading at 1.25 times its tangible book value and 9.8 times its price-to-earnings ratio, I like HSBC Holdings plc (ADR) (NYSE:HBC) as an instrument to go long European banks. Generating a great return on tangible equity (ROTE) of 12.4% and paying a 4% cash dividend yield, I think HSBC Holdings plc (ADR) (NYSE:HBC) should be 45% of the banking portfolio.
Finding value in France
Societe Generale (NASDAQOTH:SCGLY.PK) is cheap relative to its current fundamentals and looks like an opportunity when you take into account the very probable recovery of the French economy. The bank, which largely surpassed earnings per share consensus expectations in the first quarter, is taking the right measures to improve profitability. The key issues that are being taken care of are cost control and solvency. On the cost control side, Societe Generale (NASDAQOTH:SCGLY.PK) has put in place a plan to cut costs by 8.5% (off of the 2011 base) with a self-imposed deadline set in 2015. On the solvency side, the bank is delivering above expectations. The current Basel III core ratio of 8.7% shall go up to 9.5% by the end of this year.
The most attractive feature of Societe Generale (NASDAQOTH:SCGLY.PK) is its price. The bank trades at 58% its tangible book value and 5.8 times its price-to-earnings ratio. I also expect the bank to rise its dividend steadily. For 2013 I expect a 4% cash yield and for 2014 I would expect a 6% cash yield. I think Societe Generale should be 25% of this European banking portfolio.