SAN – Spain’s Santander Is a High-Yield Dynamo

Editor’s note: This column is part of our Best Stocks for 2014 contest. Bryan Perry’s pick for the contest is Banco Santander (SAN).

best-stocks-for-2014-san-stockWe’ve seen the financial sector re-emerge into a leadership role for the broader market. Future profit forecasts are increasing as a pickup in loan demand and investment services, as well as an expansion of net interest margin, is benefiting most banks’ top and bottom lines.

A gradual uptick in interest rates is very bullish for banks, as they can raise lending rates on everything from mortgages to credit lines, which drives revenue gains. The market recognizes this and has been rewarding those stocks of late.

That said, it’s too soon for me to advocate direct exposure to the U.S. megabanks, especially with the recent passage of the Volcker Rule.

The Volcker Rule is another way that the long arm of government wants to have a larger fence around the banks, but at the same time continue to get them to settle on large outdated issues to try and get back some of the TARP and HARP money that they infused in the first place, e.g. JPMorgan (JPM) which seems to be in the crosshairs of the feds time and time again.

In short, we could see banks dropping bombshells about risky securities they own and suffer market backlash.

I’m not making excuses for these domestic banks. They definitely abused their privileges, but it seems like there are two sets of rules out there. No one ever goes to jail; they just write big checks to the state, local and federal governments. Everybody walks away and kind of goes back to their desk. It’s an interesting world we live in when it comes to the regulatory process, and at the moment I’m not eager to step into mire of big U.S. banks for that reason, among others.

Why You Should Buy Banco Santander (SAN)

However, within that theme of stronger financials and opportunities for income investors, a few European-based banks with global operations stand to benefit from heavy ECB intervention and the recovering fundamentals I spelled out above.

To seize this opportunity, it’s timely to add exposure to this sector and capture an excellent yield by getting into a banking name that is well-positioned for big profits in 2014 thanks to massive restructuring: Banco Santander (SAN).

SAN is a global, multinational bank that was founded in the Spanish city of Santander in 1857. Since then, it has expanded from being simply the dominant financial group in Spain to having a presence in the United States, Latin America and several other European countries. At the close of 2012, according to its website, “Santander was the largest bank in the eurozone and one of the 13 leading banks in the world in terms of market capitalization.”

At present, the bank serves more than 100 million customers through a business model that focuses on enterprises of all sizes, from small firms to large corporations — as well as private customers, particularly through retail banks. Looking at Santander’s revenues, nearly 90% comes from that retail segment. All in all, SAN manages about 1.4 billion euros worth of customer funds from its 14,400 branches, making Santander the largest in the international banking sector.

An attractive factor in Santander’s favor is its sensible risk management. Throughout 2007, SAN stuck with its business model despite the larger industry’s preference for making risky bets to pad profits … and, as a result, it was largely untouched by the subprime mortgage crisis.

Santander is expected to monetize its substantial writeoffs and extensive recapitalization program and post solid growth next year. According to current forecasts, the business is set to record a 22% improvement in 2014 earnings, to 67 cents per share.

SAN stock pays roughly 82 cents per share annually, representing a current yield of about 9.4%. However, the dividend is subject to Spanish foreign tax of 15% that can be recouped with an amended tax filing for cash accounts — but not for retirement accounts. Consult your tax adviser in reclaiming the foreign tax.

With earnings accelerating dramatically this year and next, the current payout ratio of 139% will drop to below 100% in 2014, which should alleviate any risk of a dividend cut.

Assuming the bank executes well in the year ahead, my 12-month price target for SAN stock is $12 — or a roughly 40% return for my Best Stocks of 2014 pick.

Bryan Perry is the editor of Cash Machine. As of this writing, he was long SAN in his Cash Machine portfolio.

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