Some of my readers might remember that I looked at Delta Lloyd a long time ago as it was one of David Einhorn’s top pick back then, but we didn’t like it back then.
A quick look at the chart shows, that the problems I had identified were indeed there and the stock never really recovered:
Executive summary:
Coface SA is a relatively simple contrarian “mean reversion” case:
- the company at the moment has some specific issues which in my opinion can be solved
- the industry as such is attractive (within the generally problematic insurance space) with significant barriers to entry and little exposure to interest rates
- Even in a bad case, the downside at current depressed levels is small. A conservative “mean reversion case” would indicate ~75% upside without assuming any growth
- no hard “catalyst” and fundamentally it could get worse before it gets better
- For exposure management reasons, NN Group will be sold and replaced by Coface
- As always the reminder DO YOUR OWN RESEARCH. THIS IS NOT INVESTMENT ADVISE !!!!
The company:
Coface SA is a French “Trade Credit Insurance” company and one of the Big 3 players of this industry which together have 80% market share.
Koc Holding
Koc releaed 2014 earnings already beginning of March. Looking at the presentation (there is no English annual report yet), one can see that despite the troubles, Koc showed a remarkably solid result with overall net income up 1% against 2013, although operating profit was down -6%.
I read the earnings conference call transcript as well. The major story was that Turkey was struggling in the first 6-9 months but following the oil price decline, things seem to have improved in the last 3 months or so. This confirms the general assumption that Turkey as a large oil importer should benefit from lower oil prices.
Management made a point that the largest subsidiary, oil refiner Tupras is expected to increase earnings significantly in 2015 as a 3 bn USD investment program will be finished and the refinery then will run on full capacity. Although Tupras had losses on inventory, Koc stresses that margins are independent of oil prices.
Koc clearly has suffered as well from their USD denominated debt, but other than many EM companies, they do have a “natural” hedge because of their large, foreign currency denominated earnings stream.
Almost exactly 6 months ago, I reduced my Koc stake by 2/3 as I was worried about Turkey in general and my bad experience with Sistema in Russia. Looking back, I have to admit that this might have been a typical “fast thinking” mistake. I actually do think that Koc is a very good long-term investment if one believes in the Turkish economy. I am therefore inclined to increase the position again to around 2,5% of the portfolio, as I think that Koc with a P/E of ~10-11 is still good value, considering both, the quality of the company as well as the potential growth opportunity. The long-term downside in my opinion is relatively limited.
NN Group
NN Group had issued their annual report some days ago. Overall, earnings etc were unspectacular. However there was on extremely interesting sentence right in the beginning:
NN Group’s Solvency II capital ratio, calculated as the ratio of Own Funds (OF) to the Solvency
Capital Requirement (SCR) based on our current interpretation of the Standard Formula, is estimated to be in a range around 200% as at 31 December 2014. NN Group is considering to apply for the usage of a Partial Internal Model. The Solvency II capital ratio remains subject
to significant uncertainties, including the final specifications of the Solvency II regulations and the regulatory approval process.
This is remarkable in 2 ways. First, the Solvency II standard formula is relatively onerous so having 200% in the standard formulae is a good sign. Secondly, many competitors actually do not comment at all on their Solvency II ratios. Aegon for instance or more recently Talanx didn’t even give an indication. Swiss Life, which is not subject to Solvency II but the Swiss Solvency test (SST) also declined to give numbers.
One can of course interpret this in many ways but in my opinion, not communicating estimated SII ratios is much more a sign of weakness than anything else.
There is also a recent presentation to be found on NN website which clearly shows that their ALM matching in their big life Dutch company looks Ok. Plus they made a 200 mn EUR share repurchase (from ING) in February. Not a bad idea when the stock is valued at 0,43 times book. Overall, I am quite happy with NN despite the big fundamental headwinds for the industry. This is a stock I will invest more into when there is weakness in the stock price.
Romgaz
Romgaz issued preliminary numbers for 2014 as well. In my interpretation, they are incredibly good. Net income increased by +44% to 3,72 RON, resulting in a P/E of ~9 even before taking into account net cash. Even better, the dividend will increase to 3,15 RON or roughly 9,5% yield at current prices.
As mentioned, Romgaz is pretty independent from market prizes for the time being as they are just starting to adjust to (higher) market prices.
In any other market, this should have had at least some impact on the share price, but for now the market seems to have ignored it completely. For fun, I ran a quick correlation analysis for Romgaz since the IPO. Romgaz has a pretty low correlation to the Romanian stock index with a value of around 0,45. It is however even less correlated to any European index. For the Stoxx 600 it is around 0,21. Interestingly for the Euro Stoxx Oil and Gas it is even lower at around 0,17. As I do like uncorrelated investments a lot, this is a big plus for me.
Deutsch Bank started to cover Romgaz some days ago with a buy rating, although in my opinion with a pretty strange way of calculating the cost of capital.
Anyway, as a consequence of the great results, I increased my Romgaz position by around two percentage points to 4,2% of the portfolio at around 7,70 EUR per share.
Some quick updates on preliminary numbers form 3 of my financial stocks:
Admiral
Admiral released “preliminary annual” numbers yesterday. EPS declined slightly which was not a big surprise. My take aways at a first glance:
Negative:
– UK car still tough, UK comparison some issues due to competition, however cycle might turn in 2015
– slowing growth in Italy
Positive:
+ Italy at break even, break even in Spain expected for 2015
+ US growing strongly
+ Intenational comparison sites profitable
The CEO letter is again a must-read for anyone who is interested in Admiral and/or insurance. These guys are really different.
KAS Bank
Kas Bank came out already a few days ago with a press release on preliminary 2014 numbers. EPS almost doubled to 1,65 EUR due to the already mentioned one time effect. “Normal” earnings would have been around 0,74 EUR per share.
On the negative side, KAS Bank’s equity has been siginficantly reduced by an increase in the pension liability due to lower discount rates. Additionally they announced that they will expense 5 mn or so p.a. of the one-time gain as “investments”. Top line income acually fell but they were able to cut costs quicker. Overall, if low or negative rates will remain for a lnger time, the upside potential of KAS Bank now seems to be limited.
NN Group
Finally, NN Group came out with their 2014 results already 4 weeks ago. As with any life insurance company, they are quite difficult to interpret. What I found quite intereting is the fact that they said that their Solvency II ratio under the Standard model is 200%. Normally, most internal models show much higher solvency ratios than the standard model. In my opinion. NN Group remains the best (and only !!!) European Life insurance company to invest in despite the overall extremely difficult environment.
In any case, I will need to analyse all cases in more detail once the annual reports come out, especially with regard to KAS Bank and the pension issue.
Summary:
The recently IPOed US bank Citizens Financial Group looks like a typical “forced IPO” from a troubled regulated financial conglomerate, similar to Voya & NN Group /ING. The current valuation shortly after the IPO would imply a decent upside (~50%) even if Citizens only manages to become an “average” US regional bank.
Citizen Financial Group went public on September 24th . The story of the US-based lender is similar to the NN Group IPO in which I have already invested.
In this case, parent company Royal Bank of Scotland (RBS), which has been bailed out by the UK government following the financial crisis, is forced to concentrate on its UK business. RBS then decided to ged rid of its US business via an IPO instead of a direct sale to another buyer. It seems to be that there were quite some interested buyers.
Very similar to ING and NN Group, RBS has time until 2016 to sell down the whole stake. That this is not easy was clearly shown as RBS had to price the IPO at 21,50 USD per share, below the inital range of 23-25 USD.
Compared to other regional US banks, the valuation based on book value (and tangible book value) looks attractive:
| Name | Price/ Book | Price/ Tangible Book | ROE Current |
|---|---|---|---|
| CITIZENS FINANCIAL GROUP | 0,65 | 1,00 | -15,82 |
| REGIONS FINANCIAL CORP | 0,79 | 1,14 | 7,19 |
| ZIONS BANCORPORATION | 0,87 | 1,05 | 5,66 |
| SUNTRUST BANKS INC | 0,91 | 1,41 | 6,38 |
| HUDSON CITY BANCORP INC | 0,98 | 1,01 | 3,92 |
| KEYCORP | 1,07 | 1,21 | 8,87 |
| COMERICA INC | 1,08 | 1,19 | 7,56 |
| FIFTH THIRD BANCORP | 1,12 | 1,35 | 13,39 |
| NEW YORK COMMUNITY BANCORP | 1,17 | 2,02 | 8,35 |
| BB&T CORP | 1,20 | 1,82 | 8,00 |
| HUNTINGTON BANCSHARES INC | 1,29 | 1,44 | 10,92 |
| M & T BANK CORP | 1,37 | 2,02 | 10,76 |
| FIRST REPUBLIC BANK/CA | 1,73 | 1,84 | 13,66 |
| CULLEN/FROST BANKERS INC | 1,82 | 2,43 | 9,66 |
| SVB FINANCIAL GROUP | 1,98 | 1,98 | 11,37 |
| SIGNATURE BANK | 2,43 | 2,43 | 13,26 |
| Average | 1,28 | 1,58 | 7,70 |
If we just assume an average multiple, there would be a 50% upside based on tangible book and a 100% upside based on total book value. The problem is of course: in order to reach this multiple you have to earn the average return on equity.
Looking into the IPO filings, we can clearly see that things didn’t work that well in the past. “Normalized” earnings were around 650 mn USD in the past or ~2-3% ROE which clearly would not justify a valuation at book value. Due to the low-interest rate environment, revenues decreased and in 2013, most likely to prepare the IPO, they made a massive goodwill impairment of around 4 bn USD in 2013.
Banks as investments
As there is no shortage of material against banking and the associated risks and evil spirit, I want to outline instead what I do like about banking and this situation:
– Traditional banking in my opinion is a solid and good business if run conservatively and responsibly. Many value investors would never invest in a bank, but I have no problem with this (Mr. Buffet neither as we all know)
– Traditional banking (and Citizens is a traditional bank) profits from higher interest rates. It is easier to put margins on the loan if the nominal rate is higher. So owning a bank is quite a good interest rate hedge
– mid size banks used to have a disadvantage over the large banks, especially with regard to funding. With all the new regulation aimed at the mega banks, I think there is a much better “equal level” playing field. I like good & cheap mid-sized banks.
– I could imagine that being on its own feet, Citizen’s management can react better to local challenges and develop its business than being part of a nationalized UK banking group under constant pressure. The “spin-off effect” could be at work here. Many of the directors have purchased shares directly after the IPO. The CEO owns shares in the amount of 6 mn USD.
– Citizen does have scale on a regional level which in my opinion is quite important (see page 152 of the S1 document) in order to achieve good ROEs
– the region where they are active (North east, New England) had less issues with the housing bubble, so theoretically loan quality should be OK. Most of their business is by the way in so called “recourse states” which adds to the incentive of actually paying back personal loans
Stock overhang
RBS still owns ~66% after the IPO and a subsequent share repurchase. 2016 is not that far in the future and placing another 10 bn of shares will not be a walk in the park, but on the other hand a lot of this could be reflected already in the share price. For me it is always interesting to see when typically sell-side analysts apply a discount due to “stock overhang”. As an “intrinsic” value investor, those situations are one of the clearest situations for market inefficiencies as the intrinsic value of a company does not change because of this.
Similar to ING, I think RBS did sell the first part cheaply in order to then (hopefully) sell into positive momentum. ING for instance managed to sell Voya down from over 60% to now 32% within 1 year and the stock still outperformed the indices.
My assumption is that RBS will not sell below tangible book value which is around the current stock price. If they sell below, they will lose available capital at RBS and therefore weaken their capital base and ratios. So a scenario where RBS sells down to very low levels far below the IPO price is in my opinion not realistic.
Valuation
I am clearly not in the position to judge if CFG is an “above average” bank. However, I think one can attach a high probability to the outcome that CFG will be an average bank. The nice thing about this is that there is significant upside already to the “average case”.
Therefore I would make the following, simplified case:
I assume that there is a 50% probability that within 3 years, CFG will be an “average” bank and trade at an average valuation. Conservatively I ignore goodwill and assume a target price of 1,6x current tangible book value in 3 years which would be ~ 40 USD per share.
To keep things simple, I further assume that there is a 25% chance that they will do really well and a 25% chance that they screw up. In the downside case, I will assume a 50% loss, in the upside case I will assume a valuation at 2x tangible book or around 50 USD.
So my “expected” value in 3 years time would be (0,5*40)+(0,25*11,5)+(0,25*50)= 35,4 USD. Based on the current price of around 22,80 USD, this gives me a potential annual return of ~15,4% which looks attractive to me for such a “special situation” investment.
Summary:
Citizens Financial “forced IPO” looks very similar to ING’s NN Group and Voya IPOs. I think this could be very attractive as even the assumption of Citizens becoming an “average ROE US regional bank” has significant upside. Despite or because of the assumed “stock overhang”, the mid-term risk/relationship looks attractive although, but similar to NN Group, one should not expect a quick win here.
I will therefore invest 2,5% of the portfolio into Citizens at current prices of around 22,80 USD.
P.S.: This will be my first US stock since a long time. I don’t have anything against US stocks, but often I do not find any kind of “edge”. In this case, I do have the feeling that banks are still highly unpopular as investments in general and that there is a good chance for some market inefficiency, even in the highly efficient US market.
value and opportunity 