UniCredit Still Has Plenty of Room for Growth, So Don't Sell on Strength

 | May 16, 2017 | 9:00 AM EDT
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Investors who stuck with Italy's largest bank UniCredit (UNCFF) through its bad times had reason to be cheerful last week, when the bank's profit blew past first-quarter forecasts. The share price already has exceeded some analysts' expectations, but this does not mean its growth is done.

Last week, analysts at Societe Generale raised their target price for the Milan-traded shares of UniCredit to €17 ($18.70) from a previous target of €15 as they increased their earnings-per-share estimates for 2018 by 4% to €1.45.

The stock was trading at €17.08 on Tuesday morning, already past the target of Societe Generale analysts. The Italian bank's shares are up 25% year to date and it trades at a forward 12-month price/earnings multiple of 13.3 vs. its five-year average of 11.8, according to FactSet data.

But the bank's recovery is only beginning, so now it's not the time to take profits on its shares. On the contrary, perhaps investors who have been shunning it because of political problems in Europe should take a closer look.

One region where UniCredit is particularly strong could contribute to a lot of the bank's future growth. That region is Central and Eastern Europe (CEE). Already, it is the second-largest source of the bank's profit, after its corporate and investment banking (CIB) division.

CEE contributed €336 million of UniCredit's €907 million first-quarter profit, almost as much as CIB's €364 million. The bank is working through its bad loans in the region, as it sold more than €100 million in bad CEE loans in the first quarter. "Another €400 million are classified as held for sale and will be finally out of our balance sheet in the second quarter," Mirko Davide Georg Bianchi, UniCredit chief financial officer, said during the financial results call with analysts.

On top of the bank's own efforts to clean up its balance sheet there, the region's fortunes continue to improve. A report published last week by the Vienna Initiative -- a group comprising development banks, the European Union, the International Monetary Fund and the World Bank formed at the height of the global financial crisis of 2007-2009 -- shows that "post-crisis deleveraging seems to have been largely completed" in CEE and in Southeast Europe.

Nonperforming loans (NPLs) continued to decline, with bad loans down 8.2% year on year as of June 2016 to €52.6 billion, according to the Vienna Initiative's semi-annual NPL Monitor. That represents around 4.3% of the region's GDP. Three countries in the region -- Hungary, Macedonia and Slovenia -- have managed to reduce their NPL ratio below 10% of total loans.

In seven of the 18 countries in the region monitored by the Vienna Initative, NPLs remain high, at more than 10%. Reforms such as new out-of-court restructuring agreements, strengthening enforcement and insolvency laws or removing unfavorable tax treatments for NPLs write-offs would accelerate the reduction of bad loans.

These reforms will be slow to come, as political regimes in the region are fragile. But a strong tailwind that will contribute to the reduction of bad loans is economic growth, which has been picking up as the region's proximity to the eurozone means it benefits greatly from any improvement in the single currency area.

Exports to the eurozone, as well as remittances by eastern European workers in Western Europe, are contributing to boosting domestic spending and consumption. Countries in the region have known very strong growth in the first quarter. For instance, Poland's economy expanded at a pace of 4% in the first quarter; Romania's GDP advanced by 5.6%, surpassing analysts' expectations, according to national statistics data released on Tuesday.

Paul Fenner Leitao, credit analyst at Societe Generale, said there is room for compression in the Italian bank's corporate bond spreads: "UniCredit is one of our favorite fundamental/relative value upside stories for 2017. If the bank were based anywhere other than Italy, it would trade considerably tighter."

(This story was updated on May 18 to clarify that the Societe Generale analyst was referring to UniCredit's corporate bond spreads, not to the bank's shares.)

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