Santander (SAN)'s dividend yield, at an expected 9%, is the highest among large banking institutions, but its payout ratio is as high as it gets at an expected 119% for 2014 – down from 132% in 2013. As a matter of fact, I would not expect the bank to have a dividend payout ratio below 100% until 2016. Nevertheless, the bank's chairman – Emilio Botin – is very much committed to sustaining Santander's dividend and we should not expect this policy to change in the foreseeable future unless the Bank of Spain forbids Santander to keep on distributing cash at the current rate.
On Santander's Quarterly Results
Despite weaker results in Spain and in Latin America (Latin America constitutes almost 70% of Santander's net profits), Santander was able to post decent third quarter results thanks to better currency trends and its ameliorating UK division. Besides, through better credit metrics and cost cutting initiatives, the bank is positioned to show a much better profitability level going forward. As a matter of fact, Credit Suisse's analysts – who are not specially bullish on the name – expect Santander's profitability level (its returns on tangible book value) to increase to 14% by 2015 from the current 10%.
On the capitalization side, Santander has gotten significantly better, and I would expect the bank to show a Basel 2 tier 1 capital ratio of 12% by the end of 2014, which is around what most analysts expect for its closest peer, Banco Bilbao Viscaya Argentaria (BBVA) – most commonly known as BBVA.
On Santander's Valuation
Price is what you pay and value is what you get. In Santander's case I believe the bank is fairly valued at 2014 157% tangible book value and 12.9 times earnings but its cash dividend (which I expect to be fully sustainable from 2016) represents an added value for common passive shareholders.
Indeed, BBVA sells at a similar valuation level but pays a much lower cash yield – BBVA is expected to pay a 4% cash dividend yield in 2014. BBVA trades at 2014 150% tangible book value and 18 times earnings. While you can always acquire a solid international banking institution such as HSBC (HSBC), which pays a 4% cash yield and sells for a significantly lower valuation than both Santander and BBVA, it's nearly impossible in today's market to buy an international banking institution that would pay you a 9% cash dividend yield.
From a fundamental point of view, Santander is not relatively cheap. U.S. banks such as Citigroup (C) – which I believe is particularly cheap – sell for nearly 100% their tangible book value and they are also improving profitability fast. However, Santander offers a great cash yield to passive investors in a world where is still very difficult to find significant rates of interest. Clearly, the market does not consider that Emilio Botin's bank shall be able to sustain its dividend at the current level. I think differently. The worst seems to be over for Santander and the bank will commit itself to keep issuing large checks to its shareholders. Long story short, if you want a good income stream in cash, Santander's common shares do not look like a bad idea.