After hitting a 52-week high of 636p earlier this year, Banco Santander SA (LSE: BNC) (NYSE: SAN.US) shares have fallen by 15% to 540p.
Is this a good time for investors to add to their holdings in Spain’s largest bank — which offers a prospective yield of more than 7% — or is there worse to come?
Valuation
Let’s start with the basics: how is Santander valued against its past earnings, and the market’s expectations of future earnings?
| P/E ratio | Current value |
|---|---|
| P/E using 5 year average adj. EPS | 12.1 |
| 2-year average forecast P/E | 12.3 |
Source: Company reports, consensus forecasts
Santander’s current forecast P/E of 12.3 is in-line with its historical valuation, suggesting that the market is confident that the Spanish bank will continue to perform in-line with expectations.
A P/E of 12.3 doesn’t look expensive to me, either, especially as Santander’s prospective yield of more than 7% provides generous compensation for holding the shares.
What about the fundamentals?
I’ve been deeply impressed by Santander’s performance during the last five years. Its ability to generate cash and write off bad debts without cutting the dividend or requiring a bailout has set it apart from Spain’s other banks.
Admittedly the dividend is mostly paid in scrip form (ie, by issuing new shares) and it’s Santander’s overseas operations that have generated the cash to provide for bad debts in Spain, but the bank’s resilience has been impressive, nonetheless.
The bank’s late Chairman, Emilio Botín, promised shareholders last year that “we expect to regain our pre-crisis profit levels” in the next three years — ie, by 2016.
Do the bank’s fundamentals back up this claim?
| Metric | 5 year compound average growth rate |
|---|---|
| Net Operating income | -2.8% |
| Normalised earnings per share | -17.5% |
| Return on equity | -17.2% |
| Dividend | 0%* |
| Book value | -1.5% |
* the amount paid in Euros has not changed, although its value in GBP for UK shareholders has fluctuated with the £:€ exchange rate.
Source: Company reports
It’s clear that Santander’s profits and return on equity have plummeted over the last five years as it has been forced to write off billions of euros of bad debt. But expectations of a return to normal don’t seem completely unreasonable to me — in 2013, earnings per share rose by 71%, and the bank’s return on equity rose by 86%.
Buy Santander?
I believe Santander is an attractive buy in today’s market, although investors should be aware of the exchange rate risk involved in owning the bank’s shares. Santander’s share price (in euros) has risen by 4.5% so far this year on the Madrid Stock Exchange, but the bank’s London-listed shares are down by 1%.
Of course, exchange rate fluctuations can work in your favour, too, but it’s important to understand how this factor could reduce your dividend income, if the pound continues to gain strength against the Euro.
