Investors hope that the beleaguered European banking sector will finally see the light this year, as the European Central Bank (ECB) slowly removes its stimulus and the economy keeps strengthening. This would, in theory, allow interest rates to increase gently, which would ultimately benefit the banks as they would be able to make more money from lending out their funds.
An index of major European banks compiled by FactSet shows their share prices have been increasing in step with global stocks in the past couple of months. In terms of valuation, European banks still look cheap versus other stocks, with a forward P/E of just 11.7 compared with 16.4 for global stocks.
The ECB has halved its monthly asset purchases to €30 billion ($35.8 billion), but as part of that, it has kept corporate bond purchases unchanged at €10 billion. This is still plenty of support for the euro area's economic recovery.
An indicator measuring investor optimism regarding the situation in the eurozone increased to the highest level in more than a decade in December, according to data released on Monday. And on Thursday, Jan. 11, data out of Germany showed that the single eurozone's biggest economy expanded by 2.2% in 2017, better than the 1.9% growth it posted in 2016.
Analysts expect this pace of growth in Europe to continue this year as well. For investors who are seeking to diversify away from U.S. banks -- especially after this must-read detailed interview to Real Money's sister website The Street, in which Minneapolis Fed chief Neel Kashkari lays out research suggesting U.S. banks' capital requirements should be raised -- it is time to check out Europe's financial institutions.
Equity strategists at Societe Generale have three main themes for this year when it comes to banks in Europe: their capital situation, the potential for upgrades in earnings per share, and the potential for re-rating, or positively reassessing the companies' potential.
Here are their five key buy recommendations:
Spanish bank Santander (SAN) , which is one of the top holdings in the iShares MSCI Eurozone ETF (EZU) that is a held in the Action Alerts PLUS charity portfolio that Jim Cramer co-manages, is the first on their list.
Santander's capital is improving and getting close to gaining more flexibility, while its EPS upgrade potential is driven by a turnaround in its Brazilian operations and synergies from the acquisition (or, rather, rescue) of Spain's Banco Popular last year, in the opinion of the strategists as Societe Generale.
Their second pick is Dutch ABN Amro (ABNRY) , the highest capitalized bank in the Benelux countries. The bank's EPS are likely to benefit from improved profitability in its commercial and investment banking operations, as well as from improved asset quality. It has strong loan growth and further improving credit quality to support its profitability.
Third is Austrian Erste Bank (EBKDY) , the lender focused on Central and Eastern Europe. It has a robust capital position and margin uplift from higher interest rates in the Czech Republic, and sustained growth in volumes which is "amplifying impact on revenues".
Moreover, the bank has taken structural measures to improve its efficiency and will likely benefit from digitalization, the strategists said in their recently published research.
British bank Lloyds (LYG) , the U.K.'s biggest mortgage lender, is fourth on their list. The bank has an 8-10% free capital generation rate per year and the pricing of its U.K. products is starting to improve, the strategists wrote.
The Bank of England finally lifted its interest rate by a quarter of a percentage point to 0.5% in November last year, the first hike in more than a decade, which helped put a floor under banks' own mortgage rates. Restructuring at Lloyds after the financial crisis is "largely complete", and the bank is now starting to deliver domestic earnings and capital return, the strategists wrote.
A French bank concludes their Top 5: Credit Agricole (CRARY) , the best capitalized name in France. Its EPS upgrade potential is boosted by better volumes and credit quality trends, while investment in saving management and in Italy show potential for a positive reassessment of the name.
Societe Generale's buy recommendations generally have an absolute total return forecast of 15% or more over a 12-month period, consisting of forecast share price appreciation, plus all forecast cash dividend income, including income from special dividends, paid during the 12-month period.