Banking stocks can be terrific investments. Recently a lack of credible growth options have also seen some banks return more cash to shareholders in the form of dividends — great for those looking for income.
Banco Santander (LSE: BNC) (NYSE: SAN.US) is a noticeable absentee on this list. In fact, the bank has a most unusually shaped dividend distribution. Stay tuned to find out more about this and why I’m concerned about its sustainability. First though, let’s take a look at a big challenge facing Santander. It’s a challenge that I think the bank’s management would prefer British investors were blissfully unaware.
Dark clouds gather in Europe
The president of the European Central Bank (ECB), Mario Draghi, famously said the ECB would do “whatever it takes” to ensure the financial security of the euro zone and preserve the euro. Very basically speaking that involves a plan to underwrite the sovereign debt securities market. Now analysts speculated that this was a hollow promise because the ECB didn’t have the firepower to follow-through on this policy. Despite that, markets have yet to really call his bluff.
The growing concern now though is that the ECB and governments in the region have been caught out by recent signs of a slowdown in France and Germany. The German Economy Ministry recently reduced the country’s 2014 growth forecast to 1.2%, from 1.8%. In addition, official Eurostat figures showed that industrial production across the euro zone slumped in August by 1.8%. It’s now almost 2% lower than it was a year ago. Make no mistake the euro zone is flirting with yet another recession. Markets — for which the banks are exposed — are already getting a little fidgety.
So how exposed is Santander to the euro zone economy? Well, as a whole, the bank generates around 26% of its income from Continental Europe. Spain accounts for about 7% of the Group’s profits. Recent concerns of economic deterioration in Germany (and elswhere) though have seen Greek bond yields push up to around 9%. If the euro ‘wobble’ we’re currently experiencing continues, the bank’s European earnings may suffer.
Germany is a particularly important country to watch. Santander has more than 6 million customers in the country. Santander describes the bank’s division there as a consumer finance leader with an important retail banking business. The Spanish bank, according to its latest annual report, says it expects Germany’s contribution to the Group’s profits to rise in the coming years. That now looks less likely. This will be made more pronounced if the region’s periphery countries find themselves in trouble again in the next few months.
A neat policy now looking a bit messy
A little side-track now to Santander’s dividend policy — but stay with me.
Companies sometimes give shareholders the option of not taking dividends in the form of cash, and instead taking more shares or scrip. In Santander’s case, a bit less than 90% of shareholders choose the scrip option. That’s very unusual. It’s also interesting that even just a quick glance at the company’s earnings exposes the fact that the bank can’t afford its current payout policy.
Attributable profit in 2010 was €0.94; in 2011 it fell to €0.60; then in 2012 it slipped further to €0.23. It rose in 2013 to €0.40. The dividend payout though remained at €0.60.
Even in 2014 the dividend was once again reaffirmed at €0.60, while earnings per share rose only slightly to €0.49.
Now that’s not necessarily a problem for Santander because it’s not in effect paying out that much cash. It is, however, reliant on shareholders maintaining their current payout preferences. It’s also dependent on the continuation of favourable economic trends — which more and more commentators now question.
Some final Foolish thoughts
Still with me? Great! So all up I think management would prefer you didn’t know that City analysts expect Santander’s dividend to fall to €0.55 (£0.43) next financial year (down over 3%). That’s not really surprising considering what we know from above (the bank’s policy seems unsustainable). In addition, earnings, previously expected to rise slightly, are now in question due to the bank’s international exposures.
A lot rests on the property markets of both Britain and Spain, as well as general economic growth in Europe.
