The Operational Outlook Seems to Be Improving
Santander seems to be successfully turning around its operational main building blocks: Spain, Brazil and the UK. While the Spanish economy seems to be (very slowly) recovering from its multi-year depression, the figures tied to Santander's Brazilian business seem to be picking up as well as Santander's UK business. The pick up of the bank's building blocks along with a renewed emphasis on lowering costs should help Santander ameliorate its profitability level (returns on tangible equity) up to 14%– from the current 10% level – during the next two years.
On the other hand, Santander’s solvency ratios remain lower than its European peers such as Banco Bilbao Vizcaya Argentaria (BBVA). Under the new rules applying to Spanish banking institutions, Santander has a Basel 3 ratio of 9%, which is 0.8% lower than Banco Bilbao Vizcaya Argentaria's Basel 3 ratio. That said, Santander's capital ratios have been improving fast and the bank's Returns On Assets (ROA) doubled from 2012 to 2013. Besides, most analysts expect Santander's ROA to improve by as much as 20% in 2014.
Another critical aspect for most investors is Santander's dividend policy, which has been held in place thanks to the insistence of Emilio Botin's – the bank's almighty chairman. Most analysts still do not believe the bank will be able to sustain a dividend that implies a payout ratio well above 100% to 132% in 2013. I disagree with them. Unless the bank is forced by the monetary authorities to lower its dividend, Santander will sustain its dividend until 2015, when I would expect the payout ratio to fall below the 100% mark.
Despite improving operations, ameliorating financial strength and high cash dividend yield, for the first time in a long time I believe the Santander's price is not cheap. Santander sells for 150% its 2014 tangible book value and 12 times earnings. Meanwhile, Banco Bilbao Vizcaya Argentaria, which pays a much lower dividend yield (now at 3.3%), sells for 138% its 2014 tangible book value and 8.5 times earnings.
Other strong European banks with fairly high dividend yields such as HSBC (HSBC), which pays a 4.45% yield, also sell for much cheaper multiples. HSBC trades at 122% its 2014 tangible book value and 10 times earnings. On top of valuation, HSBC has a much better solvency profile. Its Tier 1 Capital Ratio (Basel 2) at 14% is much higher than Santander's 11.7% and Banco Bilbao Vizcaya Argentaria's 11.8%.
Once again, “Price is what you pay and value is what you get.” At Santander's current price I think there are better opportunities in the market. I believe the bank has plenty of room to further improve its operations, but I also think most of of those improvements are already reflected in the price of its shares.