Gavekal Capital: On Banking Underperformance...

Friday, January 23, 2015

On Banking Underperformance...

As we noted earlier this week, banks have significantly underperformed to start the year. In fact, on an equal-weighted, USD-basis, the banking industry has been the second worst performing industry in the developed markets (yep, the energy industry is the worst performer YTD) and banks are the fourth worst performing industry in the emerging markets in 2015.*

*Data Note: According to the GICS structure, there are three sub-industries that make up the Bank industry group. They are Diversified Banks, Regional Banks and Thrifts & Mortgage Finance. In total, there are 97 companies that fall in the Bank industry category in the developed markets and 109 companies that fall in the Bank industry category in the emerging markets. 

Developed Markets Performance By Industry
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Emerging Markets Performance By Industryimage

And over the past four years, the banking industry has been the second worst performer in the developed markets and the third worst performer in the emerging markets.

Developed Markets Performance By Industry
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Emerging Markets Performance By Industry
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Part of the recent underperformance in the developed markets banking industry may be due to cratering sales growth expectations. Sales are expected to decline by -7.6% in 2015 for the banking industry. Interestingly, earnings are still expected to grow by a relatively healthy 6.8%. Over the past six months, FY1 sales estimates have dropped by 9.4% and over the past three months FY1 sales estimates have fallen by 4.7%.  The drop in FY2 sales estimates has actually been even steeper. Over the past six months, FY2 sales estimates have fallen by 11.2% and over the past three months FY2 sales estimates have fallen by 6.5%. Lastly, only 5% of developed market banks have experienced positive FY1 sales revisions over the past six months.

Developed Markets Sales Growth Expectations
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Developed Market Earnings Growth Expectations
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Developed Markets Change In Sales Estimates
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Developed Markets FY1 Sales Revision Percentage
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It is noteworthy that declining sales expectations haven't hit emerging market banks nearly as much. Sales are expected to grow by 2.5% in FY1. Looking at the past six months, FY1 sales estimates have fallen by 7.6%, less than in the developed markets, And FY2 sales estimates have fallen by 9.2%, again less than in the developed markets. Finally, 25% of banking stocks in the emerging markets have experienced a positive sales revision over the past six months. While this doesn't seem like a lot, it is the third highest level among the 24 industries in the emerging markets and significantly above the 5% level in the developed markets.

Emerging Markets Sales Growth Expectations
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Emerging Markets Change In Sales Estimates
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Emerging Markets FY1 Sales Revision Percentage
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From a valuation standpoint, the bank industry looks relatively cheap compared to the other 24 industries in both the developed markets and emerging markets. Developed market banks have a price to cash flow ratio of 11.1x and emerging market banks have a price to cash flow ratio of 12.4x. Both are well below the respective averages in the developed markets and emerging markets universe.

Developed Markets Valuation Multiples
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Emerging Markets Valuation Multiples
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These relatively low valuation levels seem likely justified by the poor profitability delivered by the banking industry. The developed markets banking industry has the lowest return equity and the lowest return on invested capital of any industry group. Currently, the ROE of developed market banks is only 6.2% and the ROIC is only 3.1%. In the emerging markets, banks have a more respectable middle-of-the-pack ROE of 13.7% but have the third lowest ROIC at 8.3%.

Developed Markets DuPont Analysis
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Emerging Markets Profitability
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