Banco Sabadell: Dividend Expectations For The Next Few Years Have Been Cut (OTCMKTS:BNDSF)


Introduction

About a year ago, I wrote an article on Banco Sabadell (OTCPK:BNDSF) (OTCPK:BNDSY) wherein I discussed the bank’s dividend plans and the impact on its capital ratios. I mentioned that although I understood why Sabadell wanted to resume dividend payments, I also emphasized that the bank’s attempts to rebuild the balance sheet were still necessary, and if a materially adverse scenario (as defined by the European Banking Association) were to occur, the bank would see its capital ratios drop below the required minimum. I dare to say the COVID-19 pandemic could very well be the adverse economic scenario Sabadell should be fearing and in this article I’ll have a closer look at the Spanish bank.

Source: Yahoo Finance

Banco Sabadell does have a secondary listing in the US, but the OTC listing isn’t very liquid and I would recommend to only trade in Banco Sabadell through the Bolsa de Madrid stock exchange to take advantage of the superior liquidity. The ticker symbol in Spain is SAB, and the current share price is 0.316 EUR (as of the closing bell on Wednesday). Keep in mind there are 5.6 billion shares outstanding, resulting in a market capitalization of 1.77B EUR at this point.

Banco Sabadell was profitable in Q1 despite already recording COVID-19 losses

I was positively surprised when I noticed Sabadell had posted a net income of 94M EUR as I had expected the bank to show worse results as COVID-19 was having a big impact on the European economies in general, but even more so on the Spanish economy which went in lockdown for several months (and just reopened).

Source: quarterly report

In the first quarter of 2020, the bank generated a net interest income of 884M EUR, a 1.8% decrease compared to the first quarter of last year, and this was partially offset by a 1.9% increase in the banking fee and commission income which increased by 6M EUR to 349M EUR. This caused the total core revenue to come in at 1.23B EUR, roughly flat compared to Q1 2019 when the banking revenue came in at 1.24B EUR.

Source: Q1 Report

The performance was further boosted by a net trading income (and exchange differences) which pushed the total gross operating income 3.6% higher to 1.37B EUR. On top of that, Sabadell was able to reduce its operating expenses (higher staff expenses were mitigated by lower other general expenses). Ultimately this resulted in a pre-provisions income of 593M EUR, an 8.4% increase compared to Q1 2019. So far, so good, and this is a very remarkable result.

Subsequent to that pre-provision income, Sabadell needed to record a loan loss provision in anticipation of the fallout caused by the COVID-19 pandemic. The bank elected to record provisions to the tune of 400M EUR, of which 213M EUR were specifically COVID-19 related. These provisions caused the pre-tax income to drop to 141M EUR and after paying taxes the net income in Q1 was approximately 94M EUR or 1.7 cents per share. Despite this, the bank’s share price started to slide and is now trading at just over 30 cents or less than 5 times the annualized earnings based on Q1.

What can we expect in the second quarter?

That being said, simply annualizing the Q1 income is cutting a corner and not the best thing to do.

What surprised me the most after analyzing the Q1 results was the net trading income and exchange differences which more than doubled compared to Q1 2019. According to the footnotes to the quarterly report, the majority of this gain was related to the sales in the ALCO portfolio, a fixed income portfolio. It sounds like Sabadell took advantage of the low interest rates (and bonds trading at a premium to par) to monetize some of those bonds.

Source: company presentation

This could prove to be a golden move: On the one hand, the bank has boosted its liquidity ahead of the COVID-19 pandemic. Additionally, the sale has boosted the profits, and excluding those sales, Sabadell’s net income probably would have been closer to zero and would have had a negative impact on the capital ratios.

This also results in an increased level of uncertainty for the second quarter. Sabadell hasn’t provided too many details on how the trading income was realized, and whereas most financial institutions reported a loss (or neutral result) in Q1, Sabadell’s profit was an outlier. However, this also means that whereas other financials can be expected to make up some of the lost ground in Q2, Sabadell’s trading income in Q2 may not increase as strongly as its competitors as the bank outperformed in Q1.

Source: company presentation

Secondly, I will keep an eye on the loan-loss related provisions. While it’s commendable to see 400M EUR in loan loss provisions, it’s important to realize the COVID-19 related provisions were just 213M EUR. Given the loan book of Sabadell has a total size of in excess of 176B EUR (including debt securities), the Q1 loan loss provision represents just 0.12% of the total loan book and this may be a bit low so I would expect Sabadell to keep its loan loss provisions at an elevated level.

That being said, the bank will have gathered much more information on the status of its loan book during Q2 and I’m looking forward to seeing a status update when Sabadell reports its Q2 results.

The impact on the dividend

In the previous article (published in April 2019), I commented that I understood Sabadell’s desire to pay a decent dividend as that’s an important element to lure in income-oriented investors. At that point, the average analyst estimates were calling for an EPS of 0.15 EUR in 2020, and considering Sabadell was aiming to apply a 50% payout ratio, one could reasonably have expected a 7.5 cent dividend yield which would have been a dividend yield of almost 8% as the bank was trading at 97 cents per share.

But then COVID-19 happened and not only can we now completely throw the 0.15 EUR EPS out of the window, it’s unlikely that level will even be obtained in 2021 or 2022. For the record, the current average analyst estimates are aiming for an EPS of 0.02 EUR and 0.06 EUR in respectively 2021 and 2022, a substantial drop from just one year ago.

This has two important consequences. First of all, the dividend expectations of 0.075 EUR per share from last year should now no longer be relied upon. Recent buyers can still hope for a 2-4 cent dividend over the FY 2021 result (which would still be a 6-12% dividend yield based on the current share price) but anyone who bought closer to the 1 EUR range will have to be satisfied with a low single digit dividend payment per share for the foreseeable future.

Investment thesis

Seeing the dividend expectations for the next few years completely disappear is a tough view and Sabadell will likely need several years to rebuild the balance sheet to make sure the CET1 ratio continues to exceed the regulatory minimum even during severe external economic shocks.

Value investors could become more interested in Sabadell considering as of the end of Q1 the bank had a book value of 2.33 EUR per share and a tangible book value of 1.88 EUR per share which is only a minor consolation prize at this point. I have a tiny position in Sabadell at this point as some of the put options I wrote last year expired out of the money. I’m becoming very interested in Sabadell at these levels but I’m waiting for the Q2 results to see how Sabadell is dealing with COVID-19 and what its expectations are for future loan losses. The CET1 ratio still exceeds 12% so the balance sheet can handle additional loan loss provisions, but I will scrutinize the next set of results as Sabadell appears to be more speculative than other Eurozone banks.

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Disclosure: I am/we are long BNDSF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I will be looking to average down in Banco Sabadell





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