Why pick a European bank? Even worse, a Spanish bank? And even, even worse, the Spanish bank that has to raise the most capital among all European banks — $15.3 billion euros ($20 billion) — according to the European Banking Authority?
Doesn’t everyone know that Europe’s banks are headed down the tubes, that they’re insolvent, that they’re headed to bankruptcy?
Yes. But “everyone” could be wrong, and that’s exactly why you want to own Banco Santander (NYSE:STD).
There’s no denying that, on the surface, this is an ugly, ugly stock — or rather, an American Depositary Receipt, or ADR. Banco Santander traded as high as $12.72 on July 1 and as low as $6.77 on Nov. 25. That’s a 38% drop in just a few months.
The ADRs of Santander are certainly cheap: They trade at a 33% discount to book value (or a price-to-book ratio of 0.67.) And they carry a huge 10.9% yield on the company’s promised 2011 dividend. But that’s because everyone expects massive writedowns in the company’s book value as its portfolio of Spanish real estate loans and government bonds heads even further south. And because everyone expects that Santander will have to cut its dividend to meet regulators’ capital targets — even though chairman Emilio Botin promised to keep the dividend intact as recently as the end of the September 2011 quarter.
But I think Banco Santander’s price has been a victim to standard investor behavior: In a panic, the motto is “Sell everything and sort it out later.”
I think that seriously underestimates the strengths of Banco Santander — and especially the ability of what still is the world’s 11th largest bank by market capitalization to raise capital.
The worry about European banks right now is that they can’t raise capital in the financial markets. It’s just too expensive when your shares are trading at 50% or 67% of book value. As a result, they can’t reduce their asset base by selling off debt because nobody wants to buy loans to Greek companies or mortgages on Spanish real estate — and they don’t have much in the way of non-core businesses to sell off, at least not at a decent price.
During the past two quarters, Banco Santander has very clearly demonstrated that this bank doesn’t fit that profile of worries.
First, this is a global bank with plenty of attractive assets outside of the struggling Spanish and euro zone markets. In the third quarter, the bank sold a piece of its Latin American insurance business and part of its U.S. consumer loan business for a total of $3.5 billion. In the fourth quarter, it sold pieces of its Chilean subsidiary and all of its Colombia unit for $2.75 billion.
Second, Banco Santander is actually finding buyers for some of the most troubled assets in its portfolio. For example, as of Dec. 9 it had sold $8.81 billion in troubled loans at its Brazilian subsidiary, Santander Brasil. The discount was huge — loans originally valued at 16 billion Brazilian reals went for just 300 million Brazilian reals — but these loans were delinquent by a year or more and represented the most troubled part (a 9% part) of Santander Brasil’s portfolio. Getting them off the bank’s books — even at a very low price — takes a big whack at the risk-adjusted capital requirements of bank regulators.
Third, Banco Santander is actually raising capital in the financial markets — although the bank has had to use some unusual methods for doing that. For example, the bank gives holders of its ADRs the option of taking new shares, without paying withholding tax, instead of cash for their dividends. In the third quarter, 73% of ADR holders took the share offer — that added cash to retained earning and $82 million in new capital. And it’s planning to sell convertible bonds, which will count as capital.
Add in the bank’s almost $8 billion in free cash flow in the past 12 months, and I think Banco Santander won’t have any trouble presenting a plan for meeting the European Banking Authority’s capital requirements by the Jan. 20, 2012, deadline — without dipping into dividends. (The bank then will have until June 30 to execute that plan.)
Unless, that is, Spain goes the way of Greece and the country has to write down its sovereign debt. Banco Santander holds $4.4 billion less of Spanish government debt in December 2011 than it held in July 2011. But it still holds almost $50 billion in Spanish government debt.
If you think Spain will have to write off part of that debt, then Banco Santander sure isn’t the pick for you. If you think Spain is in better shape than Italy (or Greece), I think that in Banco Santander you’re looking at one of the best performers in 2012. (For more on why I think Spain isn’t headed down the tubes in 2012, see my post on JubakPicks.com.)
I’d put a target of $12 on these shares by December 2012. That’s an almost 70% gain from the Dec. 15 price.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. Banco Santander is a member of my dividend income portfolio on JubakPicks.com. The mutual fund I manage, Jubak Global Equity Fund, may or may not currently own positions in any stock mentioned in this post. The fund did own shares of Banco Santander as of the end of September. For a full list of the stocks in the fund as of the end of September, see the fund’s portfolio.
Jim Jubak is the brains behind Jubak Picks, a stock newsletter that has beaten the market since its inception in 1997. He also manages the Jubak Global Equity Fund (JUBAX) and operates Jubak Asset Management.