Category Archives: Value Stocks

Driverless cars + Uber –> Death of Car Insurance ?

As this became a long post, a quick management summary upfront:

The case for 100% self driving cars without accidents is not so clear for me
1. Based on current facts, the Google car doesn’t seem a lot better than human drivers
2. From other areas (Airplanes, chess) we can learn that a human-machine combination is often better than a “machine” alone
3. Driving cars is also an emotional experience, many people might not fully sacrifice this
4. Some innovations take longer than one thinks, especially if they take away freedom from consumers
5. A gradual decrease of claims could actually be positive for car insurers over an extended period of time

Additionally, I don’t see a combination of driverless cars with a service like Uber replacing private cars anytime soon. There are a lot of practical issues with renting out private cars to complete strangers. However, taxi driver might not be a job with a big future either.

So from my perspective, as shareholder of a car insurer like Admiral there is no reason to panic, however for traditional insurers this might be one more nail in their coffin.

Read more

Bouvet ASA Update – Annual report & Q1 2015

Bouvet is a Norwegian IT consulting company which I unfortunately “discovered” last year in August before the oil price began its free fall in autumn 2014.

Not surprisingly, the stock price suffered along the other oil dependent stocks. Despite the recent small rebound, the stock is still a relative loser for me, especially compared to the huge rally taking part in German stocks:

To add insult to injury, I lost even on the currency side as the NOK became even weaker than the EUR:

Annual Report 2014:

Let’s look at the 2014 annual report first.

Diluted EPS fell in 2014 from 6,75 NOK to 5,45 NOK. If we look at quarterly earnings over the last 2 years, we can see that already Q2 2014 showed a clear decline which then continued the rest of the year. The profit is now at 2012 levels. With a current P/E of around 14 and EV/EBIT of ~10 Bouvet is not that cheap anymore,.

Also, receivables and “work in progress” increased, resulting in a Free Cash Flow before acquisitions of only ~80% of net profit which is very low for Bouvet.

The most interesting part of the annual report was the info on the CAP Gemini acquisition. They paid 12,5 mn NOK, mostly Goodwill for Cap Gemini’s Norwegian business. This is what they say is the impact:

The acquired company has an estimated contribution with NOK 6.0 million to the Group turnover and NOK 0.6 million to the Group’s profit before tax in the period between the purchase and the balance sheet date.
Included in the value of goodwill are employees and expected synergies with Bouvet Norge’s existing business.

Had the acquisition been carried out on 1 January 2014, the Group’s estimated total turnover for the entire period would have been NOK 1 159.4 million and the Group’s estimated profit before tax would have been NOK 85.5 million.

With this information,we can easily calculate the acquisition multiple:

Stated 2014 sales of Bouvet were 1.132 mn NOK and EBT 81,6. So without the “partial” contribution, Sales would have been 1.126 and EBT 81,0. So the 12,5 mn NOK bought 33,4 mn NOK Sales and 4,5 mn NOK EBT.

Overall this looks like a pretty good deal for Bouvet. Buying at a trailing EBT Multiple of 3,5 is clearly a "bargain purchase" although it's clearly relatively small.

Q1 2015

After the pretty bad last months in 2014, I was quite surprised that they showed really strong Q1 figures for 2015. At 2,32 NOK, Q1 profit is +26,5% against Q1 2014 and EBIT margin was 9,8%, pretty close to their target.

However, Q1 always looks volatile at Bouvet, from 2012 to 2013 for instance, Q1 results dropped by 23% and Q1 2014 was around +16% against 2013.

So I do think it is too early to call a “turn around” at Bouvet, although their tone is quite optimistic:

Demand for Bouvet’s services is good and stable in Norway, and growing somewhat in Sweden.
Bouvet’s turnover is highest in the oil and gas sector, where the company has tailored its range of services and increasingly delivers to the core processes of its clients. That means the decline in sales to clients in this industry has flattened out

I found this quite interesting, as in other oil related industries (drilling etc.) we only start seeing cost cuts and project delays now in 2015. In the Q1 presentation, Bouvet gives additional information.

From my side, the most interesting developments were:

– they diversified their client base

Client portfolio

The 10 largest customers represent 39.3 percent of total revenues – down from 48.8 percent in Q1’14
The 20 largest customers represent 52.5 percent of total revenues – down from 63.6 percent in Q1’14

– they used less “hired” consultants which might explain the increase in margins to a certain extent.

Other stuff

There has been some movement in the shareholder base in the recent week. According to Bloomberg, DNB sold down around -2,5% via several funds. Handelsbanken however increased in their funds the overall position by around +2% of market cap. So overall no big net movemnet.


2014 was clearly not a good year for Bouvet and when I bought the stock, I didn’t expect the oil price to drop and their oil related business to suffer so much. On the other hand, Q1 looks very solid although one has to look if this trend really continues. Overall I do think Bouvet is a good “hold” position and if they continue to perform well I might add to the position later in the year.

Overall their strategy to be a “local Norwegian” consultant seems to work and might help them to secure more Government contracts going forward. I do expect that Norway will try to pump money into their local economy if oil stays weak and Bouvet might profit from this.

Update: TGS Nopec Annual Report 2014 and Q1 2015

TGS Nopec is one of my larger position which I bought back in November 2013 when oil (WTI) was still trading at ~100 US and the world looked great for oil and oil service companies.

In the meantime, as we all now, the oil price fell substantially since 2014 and especially oil service companies were hit hard. In contrast to other oil service companies however, TGS share price has decoupled from oil to a large extent as we can see in the chart:

This is especially interesting as 2008/2009 for instance, TGS lost almost -70% when oil crashed back then. Almost always when I discussed TGS with other investors, the argument was like this: TGS is a great company but the price has to fall at least -50% or more as it did in the past. Well, for now they are holding up pretty well.

2014 annual report

Anyway, the 2014 annual report can be found here

I would recommend anyone to read the annual report, at least the one page letter of the CEO, which in very clear words describes how TGS operates.

The highlights from my side:

– EPS dropped significantly from 2,59 USD to 2,09 USD per share
– however there were several negative one time effects included (around 65 mn USD or 60-65 cents per share).
– interestingly they make no effort to adjust those one time effects. You won’t find adjusted numbers anywhere in the report. I like this VERY MUCH.
– Operating cashflow actually increased by 10%
– Operationally, the Americas were doing very well in 2014. Asia was growing strongly but deeply negative
– payroll costs increased by ~10% in 2014
– they are still committed to invest counter-cyclical into new data by taking advantage of low charter rates for ships

Overall, they way TGS operates, 2015 will not look good from a P&L perspective, as they expense a lot of their investments and sales might take a little bit longer than usual. However if the past is any guidance for the future, in 2-3 years time the investments will then turn into nice profits down the road.

Q1 2015 update

A few days ago, even before the official Q1 report, TGS issued a Q1 update press release. They reduced significantly the expected net revenues for 2015 as E&P companeis are delaying their projects. Additionally, they announced a significant cost cutting program:

The Cost Reduction Program will position the company for the more challenging seismic market caused by the significant drop in oil price. A key element of this program is a reduction of more than 10% of TGS’ global workforce effective from April. Restructuring charges of approximately USD 4 million will be booked in Q2 as a result of this Program. The company expects annual cost savings of approximately USD 10 million as a result of the Cost Reduction Program.

Interestingly, this 10% reduction seems to off set the salary increase in 2014. At first, the market seemed to be shocked and the stock lost around -20% intraday but since then things have recovered. Maybe the recommendation change from Goldman has lifted the stock. This is what Goldman wrote last week (via Bloomberg):

(Bloomberg) — Offshore seismic market set for structural changes as oil producers rationalize costs, optimize upstream portfolios and concentrate on efficiency, Goldman says in note dated yday.
Goldman: multi-client segment has strongest outlook; data acquisition will continue to face challenges with at least six vessels needed to leave market to achieve balance
TGS raised to buy vs sell, is best-positioned in new oil order; co.’s library has highest N. America exposure which should remain most attractive onshore area
Strong financial position can sustain div.; selloff post 1Q creates buying opportunity

So it seems that this time, TGS does get better credit for their countercyclical business model than in 2008/2009. Maybe investors have learned actually a little bit since then ?.

In any case, from my side, TGS is a clear long-term core investment. Although the industry is very difficult, TGS is very good company with strong competitive advantages. Oil companies must replace their reserves,the demand for seismic data is not going away. Maybe it gets postponed a little bit ut they don’t have a choice. Without replacing reserves, atraditional E&P will not valued as going concern but as a run-off which much lower multiples.

Even with the reduced forecasts, TGS is still very profitable and who know what opportunities show up if some of the competitors get deeper into problems.

UK Banking – A look at IPO Aldermore Plc (ISIN GB00BQQMCJ47)

Within my Handelsbanken mini series (part 1, part 2, part 3), I have identified their UK business as one of the potential value drivers. So it was a luck and coincidence that a few days ago, Aldermore PLc, a “start-up” UK Bank went public.

Aldermore itself was founded only in 2009 by a then out-of-job former Barclay’s Banker called Philip Monks. They tried to go public already last year but had to pull the IPO in October.

As I have mentioned a couple of times, an IPO prospectus is always a good opportunity to learn about business models in general and about competitors and the specific sector as well.

There are some interesting parts from the prospectus on the UK banking market:

A high number of mergers and acquisitions in the sector has resulted in sector consolidation (Lloyds’acquisition of HBOS being the largest as well as a number of smaller building society takeovers such as Santander’s acquisition of Alliance & Leicester and Nationwide’s acquisitions of Cheshire, Derbyshire and Dunfermline Building Societies). This has resulted in the UK banking sector becoming one of the most concentrated and least competitive in Europe according to a Treasury Select Committee report published in 2011.

The report concluded that the top five UK banks controlled 75 per cent. of total gross new lending in total mortgages, 85 per cent. of the personal current account market and 62 per cent. of the savings account market.

For a potential shareholder in a UK banking business stock, “most concentrated and least competitive” sound not that bad as it implies some pricing power.

Handelsbanken is mentioned as one of the few foreign players:

Although there are exceptions (e.g. Handelsbanken), more generally, foreign banks have exited or reduced their presence in the UK market. For example, ING exited their mortgages and savings business and stopped writing new business in Asset Finance towards the end of 2012 and the UK business banking subsidiaries of Irish banks have restricted lending.
Furthermore, UK banks have been forced to carry out major cost-cutting exercises, including centralising credit selection functions; in some cases, ring-fencing retail operations; and spending significant amounts to improve the performance and security of their IT platforms.
UK banks have also been significantly impacted by legacy issues arising from, for example, the mis-selling of PPI and swaps and from legacy and underinvested infrastructure. Since 2011, the total bill for litigation,fines and customer redress has been £28.5 billion, equivalent to two-thirds of the cumulative profits of the top five banks over this period
 Customer dissatisfaction in the UK banking sector has also risen. One effect of this, as discussed in a recent Oliver Wyman report, is an increased propensity of customers to review and switch banking provider

Similar to my argument for Handelsbanken, UK customers seem to be fed up with UK banks and are open for new entrants like Handelsbanken and Aldermore.

As a result of these factors, there have been a number of new entrants to the UK banking market. They have adopted a variety of models targeting different credit segments (i.e. retail, SME, corporate) and adopted different distribution models (i.e. branches, intermediary, direct). These include retail-focused branch-based banks such as Metro Bank and Virgin Money and required disposals under State Aid such as Williams & Glyn (currently part of RBS) and TSB (majority owned by Lloyds Banking Group). In addition, these are specialist lenders such as Close Brothers, Shawbrook, Bibby and Paragon, challenging the share of the UK banking market controlled by the incumbents in targeted lending segments.

Aldermore however has a complete different set up than Handelsbanken. They don’t run any branches:

Aldermore does not have a traditional branch network and as such does not have the significant costs associated with running such a branch network.

Instead they run Online/Broker/intermediary based business model, claim to avoid unnecessary costs for branches.

The Directors believe that Aldermore’s branch-free distribution model is better suited to the digital era,with the regional offices representing the physical footprint that Aldermore requires to service its SME customers. The absence of a large, under-utilised branch network enables Aldermore to distribute products and service customers more cost effectively

Interestingly, their actual cost income ratio 2014 is  60% vs. 53% at Handelsbanken. This might have to do with size (Handelbanken is 2-3 times bigger). So it is clearly not a “no brainer” to run an online bank only.

What I didn’t like about Aldermore:

– Intermediary model is not that easy. They don’t have direct client contact, clients are “owned” by brokers
– How do they cope in a downturn test if work outs are necessary and they don’t have client contact ?
– large potential bonuses for management
– targets for management are only EPS and Share price

They do state an explicit ROE ambition:

The Directors are targeting a return on equity of approximately 20 per cent. by the end of the financial year ending 31 December 2016.

Targeting is great, but having it included in compensation would be even better.

Could Aldermore be the same story like Admiral 10-15 years ago ?

I think that Aldermore differs in a very important way from Admiraml: It is not structured at as capital-light model, Aldermore keeps the risk on its balance sheet and will at some point in time need additional capital if they grow like this, which then will dilute shareholders.

Additionally, they are not active in the comparison space. I do think that in the long run will bite into their profitability as the comparison siteswill be able to charge them significant comissions for referals. In the insurance space, referral fees in many cases are already as expensive as sales commissions for agents.

A good reminder that not every new and online based financial company is “the next Admiral” is for instance Vardia, the Norwegian direct insurance newcomer. After explosive growth, out of the blue they had to announce a recapitalization recently. The stock price of course got hammered.


Aldermore is clearly riding the wave of disgruntled UK bank clients, but I would not invest there. I don’t see a real competitive advantage,at least not for now.
Valuation wise, the company trades at around 2,5x book value and 15 times earnings which is OK but not cheap. The biggest risk in my opinion is that with their aggressive growth, the might attract a lot of bad risks. Their long-term underwriting abilities will be tested in the next down turn for sure. Anyway, the Aldermore IPO clearly shows that there is room for smaller players in the UK and that there is a good chance for Handelsbanken to grow for quite some time.

Additionally i would argue that the UK banking sector still looks attractive compared to other countries. In Germany for instance retail and commercial banking is dominated by Government backed banks (Sparkassen) which have a built-in advantage of extremely low funding cost. The local UK market in comparison looks much better, especially as interest rates are still positive…..

Short cuts: AS Creation, Fortum, KAS Bank annual report

AS Creation

As Creation is a stock I owned in the past. Last November I had quickly updated the case and written the following:

In any case, I don’t think AS Creation is interesting at the current level of 30 EUR. At a 2014 P/E of 15-20 (before any extra write-offs on Russia) there seems to be quite some turn around fantasy being priced in.

Just a few days ago, AS Creation came out with an anouncement. There will be no dividend and the loss for the year 2014 is 9,3 mn EUR, at the upper end of the communicated range. In parallel, the CFO left the company. The loss seems triggered by a 10 mn EUR FX loss and a 5 mn EUR fine in France. They did not give further details but one can assume that the German business wasn’t that great either.

In any case a good reminder that despite cheap fundamentals, not every “value stock” is good value.


Fortum is also a stock which I owned in the past. I sold them in autumn 2012 because I was not really convinced by the idea anymore.

Looking at the chart, we can see that Fortum has done OK since then, especially compared to like German utilities like RWE, which looked a lot cheaper back then:

Again a reminder that cheap doesn’t mean good. The even more interesting aspect is that a few days ago, Fortum finalised the sale of the Swedish power distribution grid to a consortium of pension plans and insurers for 4.4 bn EUR.

According to Reuters, the multiples were quite “Juicy” for the seller:

The deal values the network at around 16.6 times earnings before interest, taxes, depreciation and amortization (EBITDA), the same as for Fortum’s Finnish grid sale in 2013.

16,6 times EBITDA for a business which is quite comparable to my portfolio stock Electrica is an interesting price point. Clearly, you need to take some kind of discount for a recently privatized Romanian company, but I think it clearly shows what kind of prices especially pension and insurance companies are ready to pay. This makes me feel even better about the prospects of Electrica than before.

KAS Bank annual report

When I looked first at KAS Bank 2 and a half years ago, i was drawn in mostly by a very low valuation and the solid business model with a good “mean reversion” potential. that’s what I wrote back then:


KAS Bank for me looks like a very interesting opportunity within the banking sector due to the following reasons:

+ attractive specialist business model (custodian)
+ cheap valuation even based on current “bottom of the cycle” earnings
+ valuation depressed because of overall hostility against banks
+ low or no analyst coverage
+ reversion to the mean speculation a lot less risky than with normal banks as virtually no risk of dilution (even Basel III standards are met by a wide margin)
+ potential upside ~100% over the next 3-5 years plus dividends+ low correlation / beta good portfolio diversifier

The upside has realized much quicker than i thought. As of now, including dividends, the stock return +75%. So good analysis, great return ? Well not really. Actually, if I am honest, this was mostly luck as I made a big mistake or omission when i analyzed the stock: I did not look at the pension liability. And this despite the fact that I have written and warned quite often about pensions.

In Kas Bank’s case I have ignored that because the plan was funded. That was a mistake and I will show you why.

Looking into the 2014 annual report of KAS Bank, we can see that they made a nice 24 mn EUR profit this year, which includes the one time effect of the canceled German JV. However, total equity DEcreased from 213 to 194 mn EUR. As the 2014 dividend is around 10 mn EUR, the question is clearly: Where did the other 35 mn EUR equity go ?

The solution to this question can be found on page 52, in the Comprehensive Income statement: KAS Bank lost 52,6 mn EUR pre tax) because of the increase in its pension liability. 2014 has been a brutal year for pensions. The discount rate has been reduced significantly. In 2013 I didn’t pay attention, but KAS Bank used 3,9% which was on the very high-end of permitted rates for EUR. In 2014 they had to slash this to 2,2% (page 80). It gets even crazier if we look at the gross numbers on page 81. The gross DBO increase 105 mn EUR from 182 mn to 287 mn. Luckily, some of that increase could be countered by asset increases. From an overfunding of 40 mn EUR, the plan went to break even. What really surprised me is the duration of the plan with around 22 years. The problem for me is the following: Despite the current funded status, there is a significant amount of risk in the plan. The gross size of the plan is 1,5 times the equity of KAS Bank. The run a significant equity allocation (85 mn EUR or ~ 45% of KAS Banks Equity). So in a scenario with a stock market crash with continuing low-interest rates, KAS Bank would pretty quickly be forced to do a capital increase.

Additionally, the current environment is clearly not helping KAS Bank in its core business. A custody bank is always deposit rich which is a problem now. Another second level problem is mentioned on page 18:

Treasury income, mainly securities lending, decreased by 20% to EUR 11.4 million (2013: EUR 14.3 million). The lower income from securities lending was primarily due to a market wide liquidity surplus which decreased
the prices for securities lending services.

This decrease happened even before the ECB started pumping liquidity into the markets.

So overall, I have been very lucky so far. I didn’t take into account the pension liability in my first analysis and fundamentals got worse for the business itself. Nevertheless I made good money because i bought cheap enough. Optically, the stock still looks priced oK at P/B 1, trailing P/E of 7 and 5,6% dividend yield, but fundamentally, especially looking at ultra low interest rates for quite some time, KAS Bank is in my view now at fair value.

However, I didn’t want to stretch my luck too far and therefore I sold the whole position at around 11,50 EUR per share.

Handelsbanken (part 3) – where is the upside & valuation

As this turned out to be again a pretty long post, a quick “management summary” in the beginning:

1. I do think that Handelsbanken’s UK business represents a significant opportunity for long-term growth
2. Additionally, I think that well run banks are a good opportunity as banks are in general disliked and overall risks in banking have been greatly reduced
3. However, at current valuation levels, Handelsbanken is too expensive. I would be a buyer at around 350 SEK per share or ~-15% below current prices

After trying to “kill” the Handelsbanken investment case last week, now in my third post I will look at the potential upside.

From my side, there are 2 potential “catalysts” which COULD imply future upside, which are:

1. Significant growth potential in UK and Netherlands
2. (Relative) revaluation of the banking sector in the medium term

1. Significant growth potential in UK and Netherlands

If you read the Handelsbanken annual reports over the last few years, it is not exactly a secret that they have great success in the UK. This is a table I compiled from the annual reports which shows the development of the UK branches:

Branches Operating profit Total OP UK/total
2009 62 177 13727 1.29%
2010 83 417 14770 2.82%
2011 104 639 16563 3.86%
2012 133 1006 17108 5.88%
2013 161 1173 18088 6.48%
2014 178 1652 19212 8.60%

Since the end of the financial crisis in 200, Handelsbanken managed to increase operating profit in the UK 10 times and the UK business reached almost 9% of total operating profits in 2014.

Despite a higher cost/income ratio in the UK (~55%) vs the home market in Sweden (~33%), profitability as measured by ROE is already at the same level. Opening bank branches is clearly a cost factor, so one should expect cost income ratios to even go down in the UK over time.

Gross margins in the UK are clearly higher than in Sweden. In my opinion, this has two possible explanations: First, overall interest rates are higher in the UK which makes it easier to charge more. Secondly, most of the competitors (Barclay’s, HSBC, Lloyd’s, TSB) have large legacy portfolios and need to earn margins on new business.

The big question is: can Handelsbanken continue to grow and how big could this become ? One clear driver of the growth is that UK customers are fed up with their local banks. Most of them needed bail outs (RBS, Lloyds, TSB), damaged their reputation by aggressively selling questionable products and/or tax evasion etc. (HSBC’s Gulliver with his Swiss bank account as a last example).

Handelsbanken’s market share in UK so far is tiny. I tried to collect some numbers. In this 2011 report for instance, Handelsbanken didn’t even show up. This is how market shares for instance looked for personal account:

Normally, as in many industries, size does have advantages also in retail banking. Advertising for instance are expenses which scale well. In the UK however banks with large market shares face strong headwinds as outlined in this article. Interestingly, Lloyd’s with its leading market share has a cost-income-ratio of currently around 67% and this number has improved a lot over the last year. So it’s quite interesting to see that the “dwarf” Handelsbanken is already much more efficient than the big guys.

Overall, without having examined the UK market in more detail, I do think there is room for Handelsbanken to expand and reinvest capital at attractive rates for some time.

Personally, I like the organic growth of Handelsbanken a lot. In general I find that especially in the early stages, organic growth is often undervalued. Stock investors prefer often fast growth via acquisitions. You can book a lot of accounting special effects etc. and increase EPS per share much quicker. As we have seen often however, the risk of M&A deals is a lot higher and more often than not, those deals backfire and sometimes even sink the acquirer.

In the UK for instance, recently spun-off TSB has already been approached by Spanish Bank Sabadell for a potential take over a few days ago. This is of course a quick way to add a lot of branches but also a much more risky one.


Netherlands for Handelsbanken is a comparable small market. with currently 20 branches (up from 18 in 2013), the business grew by ~17%. In principle, I think the situation could be similar to the UK. a lot of the dutch banks have big legacy issues and need to earn margins. However at the moment I would look at the Netherlands as an option and not as something to actually take into account when valuing Handelsbanken.

2. (Relative) revaluation of the banking sector in the medium term

I have quickly touched this topic in the two other posts already. Banks are generally considered as “bad investments” by most participants in the stock market. This is clearly justified if we look back the last 10 years or even longer. Whereas a company like Nestle is considered a safe and promising investment at a P/E of around 23, banks are considered a pure gamble even when the trade at fractions of those multiples.

For me, this is both, a lesson in how to look at historical data and a potentially big structural investment opportunity. Let me explain why.

The main arguments against banks is that they are highly leveraged and too risky. The risk is both individual and systemic (Lehman scenario). In my opinion, the systemic risk component has been greatly reduced by what happened since the financial crisis. A lot of mechanisms have been created to prevent a second event like the run that happened in 2008/2009. For me the most important are:

– collateralization of derivatives
– bank resolution systems both national (e.g. SOFFIN) and on international level
– clear commitment and mandates of central banks
– significant increase in capital requirements internationally

For current shareholders of large legacy banks, this is not very funny at the moment. Whereas most non-banks pay dividends and buy back shares like crazy, banks have to raise capital and postpone dividends in order to shore up their capital. And clearly, in many of the mega-banks, there is plenty of toxic waste on the balance sheet to justify low valuations.

On the other hand, this creates in my opinion great opportunities for players like Handelsbanken which have little toxic waste on their balance sheet and are run efficiently. The systemic risk for those players has become a lot smaller as a potential bankruptcy of one of the old mega-banks will most likely have only little effects on other banks in the future.

The individual risk of a classic and disciplined lending bank in my opinion is relatively limited if it is run by the right people. I do not think that a conservatively run bank is riskier than any other business. I know this is a somehow controversial standpoint but to me, a standard banking business model looks a lot less complex than for instance a multi national branded consumer goods company. For me this kind of blind distrust in the banking business model creates a very interesting opportunity.

Yes, banking in general will be much more dull in the future, but als a lot safer.

The second issue I want to touch quickly is the issue of historical data. Yes, historically, banks look like terrible investments because many of them have been wiped out in the financial crisis. I cannot prove it statistically, but I think banks are also the reason why suddenly low P/E and low P/B strategies seemed to have stopped working. The now favored metric by many “data miners”, the EV has the advantage that it automatically filters out any financial company. But looking into the rear view mirror is not always the best way to make investment decisions. If you would have been a stock investor after WW II, you might not have ever invested into German or Japanese shares because they have been wiped out. But a World War luckily does not happen every 5-10 years and neither does a full-blown financial crisis.

I think that there is a good chance that due to the pressure of capital markets, in the future, returns for banks could be relatively a lot better than they have in the past, assuming that the basic banking model is here to stay. The market will squeeze banks so much that those who remain will earn good ROEs again at some point in the future. And good banks will earn very good ROEs.

Valuation exercise

There are many ways to evaluate companies. I prefer simple ones. For banks, I consider ROE and P/B as the most important factors which drive long-term returns, so a valuation model should focus on those metrics.

To have a starting point, I make the following assumptions:

– ROE will improve to 15% over 5 years (from currently 12,4%) and will stay there (15 year average is 16,5%)
– P/B will remain constant at 2,1 (15 year average is 1,7)
– Divdend payout will be 25% and handelsbanken will be able to reinvest at the above assumed ROEs

The following table translates this into a simple IRR calculation:

Current Price book 2,1                    
ROE 15%                    
ROI 7,1%                    
    1 2 3 4 5 6 7 8 9 10
Book Value 200 218,8 240,1 264,4 292,1 323,9 360,4 400,9 446,0 496,2 552,0
ROE 12,5% 13% 13,50% 14% 14,50% 15% 15% 15% 15% 15% 15%
EPS 25 28,44 32,41 37,01 42,36 48,59 54,05 60,13 66,90 74,43 82,80
Implicit P/E 16,8 16,2 15,6 15,0 14,5 14,0 14,0 14,0 14,0 14,0 14,0
Retention ratio 75% 0,75 0,75 0,75 0,75 0,75 0,75 0,75 0,75 0,75 0,75 0,75
Dividend   7,1 8,1 9,3 10,6 12,1 13,5 15,0 16,7 18,6 20,7
Target Price   459,4 504,2 555,2 613,5 680,2 756,8 841,9 936,6 1.042,0 1.159,2
NPV CFs -409 7,1 8,1 9,3 10,6 12,1 13,5 15,0 16,7 18,6 1.179,9
IRR 12,9%                  

Under those assumptions, Handelsbanken would be trading at 1.160 in 10 years time and returning me 12,9% p.a.

Now comes the interesting part: If I would want to see my 15% p.a. which I normally require, I would need to change assumptions. First I could move the purchase price down from 409 SEK. In my model, I could pay 342 SEks per share and get my 15% annual return. I could also increase my P/B multiple to 2,6 to get my 15% or I could increase the ROE to 21% after year 6 to get 15%. To be honest, both, the multiple expansion and the ROE increase seem much to aggressive to me.

So the question clearly is: Is 12,9% potential return enough or should I insist on 15% ? With the 10 year government rate in Sweden at 1%, the 12,9% would indicate a potential equity premium of 11,9% which is far more than one would normally expect from the market. On the other hand, no one knows what long-term interest rates will be in 10 years time, so betting fully on today’s low rates is also not the best solution.

This return is also driven by the assumption that Handelsbanken can continue to reinvest 75% of their profits at attractive ROEs. In Handelsbanken’s case, I don’t think that this is unrealistic. However if they could for instance only reinvest 60% and pay out the rest in dividends, then the expected return would drop to 10,7% p.a.

Anyway, for now, I would not feel comfortable investing at the current stock price level.


At the end of this mini-series, it has become relatively clear to me that Svenska Handelsbanken is really a great company, a true “Outsider” in regard to its business model and culture. Additionally, I do think that they have good growth opportunities in UK, which allows them to reinvest capital for some time to come attractive ROE’s.

In general, I believe than well run banks are one of the few potential bargains left in the market as investors hate them and do not see the greatly improved fundamentals of the financial “plumbing”.

Nevertheless, I do think that Handelsbanken does not fulfill my return requirements as the current price seems to have priced in some of this growth already. Unfortunately i was very slow in discovering Handelsbanken., as I could have bought them at an attractive only a few months ago. Nevertheless, I will keep them as my prime candidate on my watch list. I would love to add this “Outsider company” to my long-term value portfolio.

But again, patience is important. another positive aspect of this exercise is that I know now much better than before what I am looking for when I analyze a bank.

« Older Entries