DISCLOSURE APPENDIX CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, INFORMATION ON TRADE ALERTS, ANALYST MODEL PORTFOLIOS AND THE STATUS OF NON-U.S ANALYSTS. FOR OTHER IMPORTANT DISCLOSURES, visit www.credit-suisse.com/ researchdisclosures or call +1 (877) 291-2683. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. 09 June 2008 Global Equity Research Macro (Strategy) Global Equity Strategy STRATEGY Peripheral Europe: where next? When exchange rates don’t adjust, domestic price levels have to, and this tends to create far more of an asset bubble (e.g. Hong Kong 1993, Middle East today) or deflation (Germany 1998–2003). Stay short of domestic Spain and Ireland. (1) It is probable that house prices will fall c20% from here. The house price/wage ratio is 50% and 60% above average in Spain and Ireland (compared to 3% and 35% in the US and UK), respectively. The OECD claims housing is overvalued by 16% and 33% in Spain and Ireland, respectively, compared to 10% in the US. (2) Housing is still very oversupplied: starts per capita are nearly 4 times the US in both countries and would have to fall 30% and 50%, respectively, to get to previous cycle lows. (3) Leverage looks extreme, with credit/GDP of 40% above trend. (4) GDP growth is abnormally geared to property, with finance and construction at peak accounting for 38% and 45% of jobs growth in Spain and Ireland, respectively. The PMIs are now consistent with close to zero growth. (5) There has been a big loss of competitiveness: the Spanish current account deficit is 10% of GDP and Ireland’s is 6%. Spain and Ireland have the lowest export exposure to emerging markets, and Spain has the worst productivity record in the OECD. What can be done? 80% of mortgage debt is linked to short rates, which are now expected to rise in Europe. Thus, the only choice is significant deflation (and yet the real effective exchange rate is 10% and 21% overvalued in Spain and Ireland, respectively) or massive fiscal easing (with government debt/GDP low in Spain and Ireland). In our view, both will be required, resulting in Irish/Spanish bond spreads rising to 70bps from 20bps currently, threatening all domestic stocks (utilities suffer from a higher discount rate). Is it in the price? Not in Spain. Its respective P/B and P/E relatives are still 37% and 15% above the average. Domestic Spain has outperformed 1% YTD. Domestic Spanish banks trade on a 10% premium on pre-tax, pre-provisioning profits to continental Europe banks. Irish banks are cheap, but still trade on a 27% premium to UK banks (on underlying profits). Stocks with high exposure to Spain or Ireland that are cheap to short and Underperform-rated are Inditex and Bank of Ireland. The following are expensive on Credit Suisse HOLT, trades on a premium to its peer group and has negative earnings momentum: Iberia, Bankinter, Mapfre, Ryanair, NH Hoteles, Zardoya-Otis and Vocento. What about elsewhere? Greece has a current account deficit of 14% and Italy is close to recession, but we would not short banks in these countries for the following reasons: (1) Customer leverage is low: credit/GDP is less than half the average of Ireland and Spain. (2) Bank leverage is low, with particularly high deposit ratios. (3) In Italy and Greece, 35% and 30% of bank lending is to property compared with 64% and 84% in Ireland and Spain, respectively. (4) Housing is less overvalued. (5) The cost/income ratios are higher, implying more self-help potential. (6) Italian banks trade on a 28% discount to Europe. In Italy, though, with debt/GDP of 96%, bond spreads could widen beyond 100bps (from 38bps now), and thus we would sell domestic plays with negative earnings momentum, such as Mediaset and Mediolanum. Research Analysts Andrew Garthwaite 44 20 7883 6477 [email protected]Jonathan Morton 1 212 538 9853 [email protected]Luca Paolini 44 20 7883 6480 [email protected]Marina Pronina 44 20 7883 6476 [email protected]Mark Richards 44 20 7883 6484 [email protected]Sebastian Raedler 44 20 7888 7554 [email protected]
Transcript
DISCLOSURE APPENDIX CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, INFORMATION ON TRADE ALERTS, ANALYST MODEL PORTFOLIOS AND THE STATUS OF NON-U.S ANALYSTS. FOR OTHER IMPORTANT DISCLOSURES, visit www.credit-suisse.com/ researchdisclosures or call +1 (877) 291-2683. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
09 June 2008Global
Equity ResearchMacro (Strategy)
Global Equity Strategy STRATEGY
Peripheral Europe: where next? When exchange rates don’t adjust, domestic price levels have to, and this tends to create far more of an asset bubble (e.g. Hong Kong 1993, Middle East today) or deflation (Germany 1998–2003).
Stay short of domestic Spain and Ireland. (1) It is probable that house prices will fall c20% from here. The house price/wage ratio is 50% and 60% above average in Spain and Ireland (compared to 3% and 35% in the US and UK), respectively. The OECD claims housing is overvalued by 16% and 33% in Spain and Ireland, respectively, compared to 10% in the US. (2) Housing is still very oversupplied: starts per capita are nearly 4 times the US in both countries and would have to fall 30% and 50%, respectively, to get to previous cycle lows. (3) Leverage looks extreme, with credit/GDP of 40% above trend. (4) GDP growth is abnormally geared to property, with finance and construction at peak accounting for 38% and 45% of jobs growth in Spain and Ireland, respectively. The PMIs are now consistent with close to zero growth. (5) There has been a big loss of competitiveness: the Spanish current account deficit is 10% of GDP and Ireland’s is 6%. Spain and Ireland have the lowest export exposure to emerging markets, and Spain has the worst productivity record in the OECD.
What can be done? 80% of mortgage debt is linked to short rates, which are now expected to rise in Europe. Thus, the only choice is significant deflation (and yet the real effective exchange rate is 10% and 21% overvalued in Spain and Ireland, respectively) or massive fiscal easing (with government debt/GDP low in Spain and Ireland). In our view, both will be required, resulting in Irish/Spanish bond spreads rising to 70bps from 20bps currently, threatening all domestic stocks (utilities suffer from a higher discount rate).
Is it in the price? Not in Spain. Its respective P/B and P/E relatives are still 37% and 15% above the average. Domestic Spain has outperformed 1% YTD. Domestic Spanish banks trade on a 10% premium on pre-tax, pre-provisioning profits to continental Europe banks. Irish banks are cheap, but still trade on a 27% premium to UK banks (on underlying profits). Stocks with high exposure to Spain or Ireland that are cheap to short and Underperform-rated are Inditex and Bank of Ireland. The following are expensive on Credit Suisse HOLT, trades on a premium to its peer group and has negative earnings momentum: Iberia, Bankinter, Mapfre, Ryanair, NH Hoteles, Zardoya-Otis and Vocento.
What about elsewhere? Greece has a current account deficit of 14% and Italy is close to recession, but we would not short banks in these countries for the following reasons: (1) Customer leverage is low: credit/GDP is less than half the average of Ireland and Spain. (2) Bank leverage is low, with particularly high deposit ratios. (3) In Italy and Greece, 35% and 30% of bank lending is to property compared with 64% and 84% in Ireland and Spain, respectively. (4) Housing is less overvalued. (5) The cost/income ratios are higher, implying more self-help potential. (6) Italian banks trade on a 28% discount to Europe. In Italy, though, with debt/GDP of 96%, bond spreads could widen beyond 100bps (from 38bps now), and thus we would sell domestic plays with negative earnings momentum, such as Mediaset and Mediolanum.
Spain and Ireland: more to go for on the downside Country factors should start to dominate again as the ECB starts to raise rates. In an environment where interest rates and the exchange rate can't adjust, there is even more onus on domestic prices and asset prices to decline in those countries which are the most overleveraged, the most reliant on short-term debt, have the most overvalued housing market and have the most overvalued currencies.
A year ago, we published a long report (After the boom, dated 14 May 2007) suggesting that investors should be very short of domestic Spain and Ireland.
Clearly this has become a consensus call in the same way as shorting domestic UK had become a consensus call by the end of last year, but this does not mean that the consensus is wrong. Indeed, sometimes the most money is to be made on these calls.
Macro problems are getting worse: Spain and Ireland (1) Confidence indicators are deteriorating much faster than in other European countries.
Figure 1: Business confidence is collapsing... Figure 2: ... followed by consumer confidence
RESERVED, number of standard deviations from long-run average
According to our economics team, the regional PMIs are consistent with a GDP growth close to zero in Ireland and Spain (see Appendix 1). The rise in unemployment is even more alarming, especially if compared to the European average. The rise in unemployment reflects weakness in the finance/construction sector (which have accounted for 45% and 38% of total Irish and Spanish employment growth, respectively, in 2007), as shown below.
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Global Equity Strategy 3
Figure 3: Unemployment rates in Spain, Ireland and EU15 Figure 4: Employment growth in Finance/Construction
(2) The slowdown in construction activity and house prices is accelerating significantly, as shown below. Figure 5: House prices in Spain and Ireland Figure 6: Construction activity in Spain and Ireland
These are the results of the lagged response to higher ECB rates (more than 80% of mortgages are variable-rate) but also of the extreme overvaluation of the property markets. Critically, the Spanish and Irish property markets remain very expensive, as shown below. House prices relative to wages are still 50% above average in Ireland and 60% above average in Spain. This compares to the US and UK, where the house price/wage ratios are 3% and 35% above the average, respectively.
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Global Equity Strategy 4
Figure 7: House prices – deviation from “fair” value (IMF) Figure 8: House prices to wage ratio still very high
And residential rental yields are low relative to bond yields, as shown below.
Figure 9: Residential yields minus bond yields in Spain and Ireland are the lowest in
Europe
-200
-100
0
100
200
300
400
500
Spai
n
Irela
nd
Nor
way
Hun
gary
Italy
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Pola
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Residential y ields minus bond y ields
Source: Global Property Guide
And, looking at the level of housing starts, the correction is far from over. Our Spanish banks analyst, Santiago Lopez Diaz, believes that a decline of up to 40% from a 2006 peak of 750k is realistic.
A good measure of oversupply is the level of housing starts/permits per capita. Again, Ireland and Spain score at the top, with a level which is about 4 times higher than in the US and UK, as shown below. We can also see that housing starts per capita in Spain and Ireland are only back to levels seen 3 years ago, whereas in the US housing starts per capita are back to levels last seen in 1991.
If housing starts per capita fell to the average level seen in US, then there would be a 60% fall in housing permits.
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Global Equity Strategy 5
Figure 10: Housing starts/permits per capita very high in
Spain and Ireland
Figure 11: Housing starts/permits per capita in Spain and
We would highlight that housing starts are collapsing in Spain and Ireland, but to return to previous cycle lows they would have to fall by an additional 30% and 50%, respectively, as shown below.
Of course, the Spanish and Irish economies are very sensitive to the property market. Construction investment accounts for a disproportionately large share of Spanish and Irish GDP, 11% and 8%, respectively (13% share of total employment).
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Global Equity Strategy 6
Figure 14: Construction as a share of GDP and total employment (4Q 2007) Construction as % GDP Construction employment as a % of
total employment Ireland 8 13.2
Spain 10.9 13
Finland 5.9 7.5
Austria 7.1 na
Netherlands 5 5.8
Euro area 5.9 7.7
France 6.1 7
Portugal 5.5 na
Italy 5.6 7.7
Germany 3.5 5.4
United Kingdom 6.2 4.7
US 4.8 5.3
Source: Credit Suisse European economics team
However, they have contributed 0.8% to annual GDP growth over the past 3 years in both Ireland and Spain. (The construction and financial sectors have accounted for 46% and 20% of total Irish and Spanish employment growth, respectively, since 2004.)
(3) Excessive leverage for Spain/Ireland, as shown in the high level of private domestic debt relative to GDP per capita.
Figure 15: Domestic credit to GDP and GDP per capita
An additional problem is that in Spain and Ireland a high proportion of mortgage debt is floating, making these countries much more vulnerable to concerns that European inflation remains above target (and that the ECB will postpone rate cuts).
Figure 18: High proportion of variable-rate mortgages in peripheral Europe
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Source: OECD, European Mortgage Federation
(4) Big loss of competitiveness, as shown by the large current account deficits and the overvalued real effective exchange rate (due to respective Spanish and Irish domestic inflation rising, cumulatively, 11% and 12% faster than Euro-area average since 1997).
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Global Equity Strategy 8
Figure 19: Spain and Ireland have big current account
This probably means that we need to see a 20% and 10% decline in the real effective exchange rate in Ireland and Spain, respectively, just to get back to a ‘neutral’ level. We suspect that given the problems in housing/construction, we have to see the real effective exchange rate undershoot.
Since productivity growth is very weak (as we show below), this can only be achieved by a sharp decline in wage costs relative to the rest of Europe, maybe by as much as 10–15% relative to Europe in Spain and more so in Ireland.
This has to be very bad for domestic consumer-based stocks in these countries.
(5) Very low productivity growth. Spain, in particular, has experienced an almost unprecedented decline in labour productivity in the last decade, as shown below. (The good news is that productivity growth has been positive since 2006.)
Figure 21: Productivity growth and level very low in Spain
20
25
30
35
40
45
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55
1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
GD
P pe
r H
our
(USD
PPP
)
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UK Ireland
Source: The Conference Board
09 June 2008
Global Equity Strategy 9
(6) Low exposure to emerging markets, as shown below.
Figure 22: Ireland and Spain have relative low exposure to emerging markets
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Ireland UK Spain EuropeanUnion
France Germany Austria Italy Greece
Exports to developing countries, % total
Source: IMF
In addition, Spain is more exposed to competition from emerging markets than the European average (35% of total imports come from emerging economies, 31% in the EU).
The positives: fiscal surplus and demographics
We, of course, acknowledge that both Ireland and Spain have the fiscal flexibility to support their economies (both countries have budget surpluses and central government debt/GDP ratio of 21% and 30%, respectively).
Figure 23: Fiscal debt to GDP (central government, 2007)
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Aust
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Nor
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Irela
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Italy
Gre
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Gov ernment debt/GDP
Source: OECD
But investors always underestimate the degree to which fiscal positions deteriorate into a sharp economic downturn as tax revenues decelerate. In a normal downturn we would expect the cycle alone to add about 2-3 pp to the fiscal deficit; for instance, in 2000–03 the deficit rose from 0% to 3.1% of GDP in the Euro-area. (Government revenues rose 1.5% and spending 9% in real terms.)
09 June 2008
Global Equity Strategy 10
Spain has just announced a fiscal stimulus package worth €€ 10bn over 2 years. This amounts to 0.9% of GDP, including an income tax rebate of €€ 400 for this year and next; a programme to retrain unemployed construction workers; and a plan to promote more housing subsidized by the state. However, we feel that we are likely to get very aggressive fiscal spending.
After all, even in the good times Italy and France were running budget deficits of more than 2% of GDP, and of course the Maastricht criteria allow countries to run budget deficits of 3% of GDP or more in a recession. Thus, we believe that there could be massive fiscal easing, as this is the only way to counter the deflationary threat to these economies. If the exchange rate can’t devalue and rates can’t fall, then all the hard work has to be done via domestic prices, wage levels and fiscal policy.
In addition, population growth has been very strong in the last decade, especially in comparison with other European countries, and it remains so. This is, of course, an offset for declining productivity growth.
Figure 24: Solid fiscal balance in Spain and Ireland... Figure 25: …and exceptional population growth (2007)
We worry that often demographic inflows are a function of opportunities as well as wage differentials. Both clearly have diminished. Below, we show that the boost to the supply side in Spain in terms of population growth has largely come from immigration.
Figure 26: Population growth in Spain Figure 27: Immigration has been a key driver of the supply side stimulus in Spain
Spain Contribution of Migration to Population Change
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1960-1965
1970-1975
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2000-2005
2010-2015
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Natural Population Change Change due to Migration
Source: OECD Source: OECD
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Global Equity Strategy 11
Valuation not attractive We calculate that roughly 50% of the Spanish and Irish markets are related to domestic earnings. We show in aggregate that Spain is looking expensive on a P/E and P/B basis relative to history, while Ireland is not.
Figure 28: Spain 12m fwd P/E relative to Europe ex-UK Figure 29: Ireland 12m fwd P/E relative to Europe ex UK
It is clearly far more relevant to focus on domestic area, and here we find that domestic Spanish stocks have slightly outperformed, while domestic Irish stocks have underperformed the European market since January.
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Global Equity Strategy 12
Figure 32: Domestic Spain relative to Europe and Domestic Ireland relative to Europe
Banks We are still short of the Spanish domestic banks:
First, their performance has been surprisingly strong – though BBVA and Santander, which have a big earnings exposure to booming Latin America (respectively 45% and 34% of net income) have performed better than domestic banks, as shown below.
Figure 33: Spanish banks have outperformed European
And, above all, domestic Spanish banks trade on a 10% premium to the rest of Europe on price to pre-tax, pre-provisioning profits. Irish banks trade on a discount.
Figure 37: Domestic Spanish banks trade on price to provisioning profits
Company CountryLoan-to-deposit
Leverage (tangible)
Price-to-book 12m fwd PE
Pre-prov pre-tax PE
Credit Suisse Rating
BANKINTER, S.A. ESP 2.41 28.6 2.8 12.8 6.6 UNDERPERFORMBANCO PASTOR, S.A. ESP 1.64 17.1 1.9 9.9 5.8 UNDERPERFORMBANCO POPULAR ESPANOL ESP 2.29 18.7 2.3 9.3 5.5 UNDERPERFORMBANCO SABADELL ESP 2.09 19.7 2.0 10.4 6.5 UNDERPERFORMBANCO BILBAO VIZCAYA ARGENTARIA SA ESP 1.46 26.0 2.3 8.1 5.1 OUTPERFORMBANCO SANTANDER SA ESP 1.90 22.9 1.7 8.6 5.6 OUTPERFORMSpain average (median) 1.99 21.3 2.1 9.6 5.7Spain average ex BBVA & BSCH (median) 2.19 19.2 2.1 10.2 6.2European average (median) 1.58 25.9 1.6 8.6 5.6
Source: Credit Suisse HOLT
Both Spanish and Irish banks have very high exposure to property and construction, as shown below.
Figure 38: Exposure of banks to property and construction, % total lending
Source: Credit Suisse European banks team. Credit Suisse research
09 June 2008
Global Equity Strategy 14
It is only now that we are beginning to see the slowdown in loan growth and a rise in provisioning as unemployment starts to rise. Clearly, in both economies loan growth has to slow further and there is significant operationally leverage to this. Moreover, provisioning has to rise a lot further. Figure 40 shows that NPLs could easily rise to 3% from 1% currently if the unemployment rate rises by 2 pp.
Figure 39: Loan growth in Spain and Ireland (y/y%) Figure 40: Provisioning rises as unemployment rises
We do acknowledge that Spanish banks tended to have more conservative LTV ratios (a capital charge is applied if LTV is higher than 80%), far less use of SIVs (owing to the penalty imposed by the Bank of Spain) and stricter NPL standards. Also, into a default scenario, banks can take control of all the assets of an individual (not only his property). From this point of view, Spanish banks have potentially better recovery ratios than their European counterparts.
Irish banks have performed worse, and look relatively cheaper against both their history and their peer group.
Figure 41: Irish banks have underperformed in the last
But when we look at pre-provisioning profits, we find that valuations are again not particularly cheap: Irish banks trade on a 27% premium to UK banks on underlying profits and BoI has nearly 40% of its exposure to UK commercial and residential real estate.
Figure 43: Irish banks trade on a discount to European peers on price to provisioning profits
BANK OF IRELAND IRL n/a 31.8 1.3 5.5 4.0 UNDERPERFORM
Irish average (median) 1.69 24.2 1.4 5.5 4.2
UK average (median) 1.53 36.6 1.4 5.6 3.3
European average (median) 1.58 25.9 1.6 8.6 5.6
Source: Credit Suisse HOLT
Other domestic stocks We believe investors should be short of domestic Spain and Ireland not only because of the growth outlook but also because a likely widening in bond spreads, as fiscal positions deteriorate, would require a higher discount rate on all domestic stocks
We screen for stocks with more than 40% of their revenue from Spain and Ireland. Below we show stocks with downside on HOLT and negative earnings momentum. We also include those companies rated Underperform by Credit Suisse analysts. The stocks that trade on a premium to their global peer group with negative earnings momentum and expensive on HOLT are: Mapfre, Bankinter, Vocento, NH Hoteles, Iberia, Zardoya-Otis and in Ireland, Ryanair and Irish Continental Group.
Figure 44: Domestic Spanish stocks that have downside on HOLT and negative earnings momentum OR are rated
One of the criticisms with our view of Spain and Ireland is that it is shared by many investors. But consensual positions can still be profitable. Below, we show how many shares are currently borrowed as a percentage of those available (the “utilization” column in the table). This gives an indication to the practicalities of going short. Allied Irish stands out as a stock that does not appear to have been aggressively sold short. Note how large the number is for some of the Spanish banks. For more information please speak to the Credit Suisse Stock Lending desk.
Figure 46: Cost of shorting domestic Spanish and Irish stocks that are rated Underperform by Credit Suisse analysts
Company CS rating Short Interest Utilization, % of available
Banco Popular Espa Underperform 106,580,000 79% 7.5% fee -72
Source: Data Explorer, Credit Suisse, *Credit Suisse Stock Lending desk
Italy and Greece – are they different? Superficially, Italy and Greece may look as vulnerable as Spain and Ireland. They have slowing growth and consumer confidence and slowing house price inflation, as well as high current account deficits and real effective exchange rates – which is, of course, hurting their competitiveness.
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Global Equity Strategy 17
Figure 47: OECD lead indicators (6M ann.) for Italy and
Greece
Figure 48: Consumer confidence in Italy and Greece
We, of course, acknowledge that Italy and Greece have government debt/GDP ratios of 96% and 105%, respectively (which make aggressive fiscal stimulus packages unlikely), and Greece has a current account deficit of 14% - which must be financed by capital inflows. However, the two countries look better than Spain and Ireland for the following reasons:
Figure 52: Life premiums as a share of GDP and GDP per capita
US
Canada
Mexico
Brazil
Chile
Argentina
Colombia
United Kingdom
France
Germany
Switzerland
NetherlandsItaly
Spain
Sweden
Belgium
Ireland
Finland
Denmark
AustriaNorway
Russia
Portugal
Hungary
Czech Republic
Greece
Poland
JapanSouth Korea
Taiwan
Hong Kong
Israel
China
Indonesia
Thailand
Malaysia
Singapore
Philippines
South Africa
Australia
New Zealand
0%
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6%
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GDP per capita, US$ '000s
Life
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% o
f G
D
Source: OECD, Credit Suisse Insurance Team
(3) Less of a housing bubble.
During the last 10 years, house prices have risen 102% in Italy and 150% in Greece, against an increase of 240% in Ireland and 190% in Spain. As a consequence of that, rental yields relative to bond yields remain well below Spanish or Irish levels. According to our European bank team, there is no evidence to suggest that there has been a housing bubble in either Italy or Greece – so banks’ exposure to the sector is not a big concern.
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Global Equity Strategy 19
Figure 53: Greece and Italy have higher rental yields than Ireland and Spain
Italy and Greece exports to emerging markets are 33% and 39% of their total exports, respectively, among the highest in Europe. As shown on page 9, the respective figures for Spain and Ireland are 24% and 12%.
(5) Unemployment has not yet started to rise.
Figure 54: Unemployment rates are not rising in Italy and Greece
Superficially, on the banks, there is also less downside risk as:
(1) High cost-cutting potential in Italy.
The cost/income ratio in Italy is still relatively high, indicating self-help is still a theme.
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Global Equity Strategy 20
Figure 55: European banks: median cost-income ratio by country
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GR
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IRL
Cost-to-income ratio
Source: Credit Suisse HOLT
(2) Lower exposure to the construction/real estate sectors (see page 13).
We do not get a detailed breakdown of the loan book for Italian or Greek banks, but our analysts believe that their exposure to the sector does not pose obvious risks. Additionally, the exposure to property developers is rather small – in Greece below 3%, according to our analyst, Petros Katsoulas. Total exposure to property and construction is 30% for Greece and 35% for Italy. Thus, Italian banks are much more of a play on the corporate which looks generally in a better state than the consumer sector.
(3) Very stable, low-cost deposit base, as shown in the ratio of sight deposits to total private loans.
And along with this, they have structurally much lower rates of leverage, thus their RoE are much more sustainable.
Source: Credit Suisse European Banks team Source: Credit Suisse HOLT
(4) More attractive valuations for Italian banks. P/B of Italian banks are at a 20-year low relative to continental European banks, while on relative PE Italian banks look close to fair value.
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Global Equity Strategy 21
Figure 58: Italian banks attractive on relative PB... Figure 59: ...but relative P/E is close to long run average
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1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Italy banks PB rel. to EMU
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Jul-95 Sep-97 Nov-99 Jan-02 Mar-04 May-06 Jul-08
Price to forward Earnings - Italy Banks rel. to EuropexUK Banks
NATIONAL BANK OF GREECE, S.A. GRC 0.94 24.7 3.5 8.9 7.6 OUTPERFORM
CREDITO EMILIANO SPA ITA 1.57 17.6 1.7 8.8 5.1 n/r
BANCA POPOLARE DI MILANO ITA 1.50 15.2 1.1 8.3 4.0 n/r
BANCA CARIGE SPA - CASSA DI RISPARMIO DI GITA 1.94 12.6 1.6 17.1 8.6 n/r
BANCA MONTE DEI PASCHI DI SIENA SPA ITA 1.96 21.3 1.0 8.9 2.9 RESTRICTED
UBI BANCA ITA 1.90 18.7 1.0 9.7 7.7 OUTPERFORM
BANCO POPOLARE ITA 1.86 28.8 0.9 8.4 5.5 NEUTRAL
UNICREDITO ITALIANO SPA ITA 1.70 30.3 1.3 7.9 5.1 OUTPERFORM
INTESA SANPAOLO SPA ITA 1.78 21.2 1.3 8.8 8.2 NEUTRAL
Greece average (median) 1.22 17.9 3.0 9.8 7.7
Italy average (median) 1.82 19.9 1.2 8.8 5.3
European (median) 1.58 25.9 1.6 8.6 5.6
Source: Credit Suisse HOLT
Diverging growth = diverging bond spreads? We can see already that PMI differentials are increasing and bond spreads are widening. However, we find it very surprising that widening fundamentals – Germany still growing at a solid pace, peripheral Europe falling into recession - are still not reflected appropriately in bond spreads (country risk), as shown below.
calculated as the standard deviation over the last 4 months
We think that bond spreads would have to rise significantly from here, reflecting also the higher risk of a break-up of the Euro. Clearly, widening economic performance makes a uniform monetary policy much less effective and vulnerable to political intervention.
Higher bond spreads in peripheral Europe will of course raise the cost of capital for companies operating there, with a negative impact on earnings multiples. We would not be
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surprised by a recession scenario, with the ECB raising rates and the Spanish and Irish bond spreads rising 50bps or higher.
In Italy though, with debt to GDP of 96%, bond spreads could widen beyond 100bps (from 38bps now), and thus we would sell domestic plays, and those with negative earnings momentum in particular.
Figure 64: Domestic Italian stocks that have downside on HOLT and negative earnings momentum OR are rated
In terms of relative performance, Greece and Spain have done better than Ireland and Italy in the last 12 months, as shown below. We would highlight that this performance divergence is partially explained by developments in country risk, as shown in Figure 66. (Yield spread against Germany has widened by 17bps in Spain and by a much higher 31bps in Ireland.)
Figure 65: MSCI indices performance... Figure 66: ...partially explained by perceived country risk
Companies Mentioned (Price as of 05 Jun 08) Acerinox (ACX.MC, Eu16.52, UNDERPERFORM, TP Eu16.00, OVERWEIGHT) Agricultural Bank of Greece (AGBr.AT, Eu2.54, NEUTRAL, TP Eu2.80, OVERWEIGHT) Allied Irish Banks (ALBK.I, Eu12.34, UNDERPERFORM, TP Eu15.00, OVERWEIGHT) Alpha Bank (ACBr.AT, Eu21.92, OUTPERFORM, TP Eu27.50, OVERWEIGHT) Anglo Irish Bank (ANGL.I, Eu7.86, NEUTRAL, TP Eu11.35, OVERWEIGHT) Banco Espanol de Credito (Banesto) SA (BTO.MC, Eu10.76, UNDERPERFORM, TP Eu12.50, OVERWEIGHT) Banco Pastor (PAS.MC, Eu9.29, UNDERPERFORM, TP Eu9.50, OVERWEIGHT) Banco Popolare (BAPO.MI, Eu12.56, NEUTRAL, TP Eu14.30, OVERWEIGHT) Banco Popular (POP.MC, Eu9.80, UNDERPERFORM, TP Eu11.00, OVERWEIGHT) Banco Sabadell (SABE.MC, Eu6.21, UNDERPERFORM, TP Eu6.50, OVERWEIGHT) Banco Santander Central Hispano SA (SAN) (SAN.MC, Eu12.81, OUTPERFORM, TP Eu17.00, OVERWEIGHT) Bank of Ireland (BKIR.I, Eu7.50, UNDERPERFORM, TP Eu9.00, OVERWEIGHT) Bankinter (BKT.MC, Eu9.27, UNDERPERFORM, TP Eu9.00, OVERWEIGHT) BBVA (BBVA.MC, Eu13.89, OUTPERFORM, TP Eu20.00, OVERWEIGHT) EFG Eurobank Ergasias (EFGr.AT, Eu18.56, OUTPERFORM, TP Eu26.00, OVERWEIGHT) Enel (ENEI.MI, Eu7.18, UNDERPERFORM, TP Eu7.00, UNDERWEIGHT) Inditex (ITX.MC, Eu32.41, UNDERPERFORM, TP Eu27.00, UNDERWEIGHT) Intesa Sanpaolo (ISP.MI, Eu4.05, NEUTRAL, TP Eu5.30, OVERWEIGHT) Mapfre SA (MAP.MC, Eu3.42, NEUTRAL, TP Eu3.47, MARKET WEIGHT) Mediaset (MS.MI, Eu5.11, UNDERPERFORM, TP Eu5.30, UNDERWEIGHT) Mediolanum (MED.MI, Eu3.51, UNDERPERFORM, TP Eu4.34, MARKET WEIGHT) Monte dei Paschi di Siena (BMPS.MI, Eu1.92, RESTRICTED) National Bank of Greece (NBGr.AT, Eu34.12, OUTPERFORM, TP Eu48.00, OVERWEIGHT) Ryanair (RYA.I, Eu3.23, NEUTRAL, TP Eu2.50, MARKET WEIGHT) Telecom Italia (TLIT.MI, Eu1.45, UNDERPERFORM, TP Eu1.40, MARKET WEIGHT) UBI Banca (UBI.MI, Eu16.15, OUTPERFORM, TP Eu21.50, OVERWEIGHT) Unicredito (CRDI.MI, Eu4.32, OUTPERFORM, TP Eu5.70, OVERWEIGHT) Union Fenosa (UNF.MC, Eu41.82, UNDERPERFORM, TP Eu41.50, UNDERWEIGHT)
Companies not rated mentioned in the report A2A Spa, Autogrill Spa, Cir-Compagnie Inds, Abertis Infraestr, Acs Actividades Co, Aguas De Barcelona, Bca Carige Spa, Bca Pop Di Milano, Bk Of Piraeus, Cia Esp Petroleos, Credito Emiliano, Ebro Puleva Sa, Emporiki Bank, Faes Farma Sa, Glanbia, Greek Postal Savin, Grifols Sa, Iaws Group, Iberia Lineas Aere, Irish Contl Group, Kerry Group, Laboratorios Almir, Metrovacesa, Mondadori Edit, Rcs Mediagroup, NH Hoteles, Obrascon Huar Lain, Prosegur Seguridad, Sol Melia Sa, Viscofan Sa, Vocento, Zardoya-Otis
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Disclosure Appendix Important Global Disclosures The analysts identified in this report each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities. Analysts’ stock ratings are defined as follows***: Outperform (O): The stock’s total return is expected to exceed the industry average* by at least 10-15% (or more, depending on perceived risk) over the next 12 months. Neutral (N): The stock’s total return is expected to be in line with the industry average* (range of ±10%) over the next 12 months. Underperform (U)**: The stock’s total return is expected to underperform the industry average* by 10-15% or more over the next 12 months.
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The following disclosed European company/ies have estimates that comply with IFRS: ACX.MC, AGBr.AT, ALBK.I, ACBr.AT, ANGL.I, BTO.MC, BAPO.MI, POP.MC, SABE.MC, SAN.MC, BKIR.I, BKT.MC, BBVA.MC, EFGr.AT, ITX.MC, ISP.MI, MAP.MC, BMPS.MI, NBGr.AT, RYA.I, CRDI.MI, UNF.MC, ENEI.MI, MS.MI, MED.MI, TLIT.MI.
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