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Matthew Sipos
Matthew Sipos
Articles (9) 

Value Idea Contest: Credit Suisse as a Value Investment?

Credit Suisse is the second largest bank in Switzerland and is famous for being a safe haven in the money world

December 10, 2018 | About:

1. Company

Credit Suisse (NYSE:CS) is the second largest bank in Switzerland and is famous for being a safe haven in the money world. As one of the members of the "Bulge Brackets” club – which comprises nine of the largest and most profitable banks in the world  it is a very important member of the global world economic system. Credit Suisse is an investment bank with a strong wealth management division – currently thinning down the investment banking segment.

In the 2008 Financial Crisis the banking industry lost its reputation and investors’ trust. Today, bank stocks are still low priced due to strict regulations, government investigations, low interest rates and increasing competition from the technology sector. Many investors question the future prosperity of the old banks.

If you check the chart of this stock, you can see a stagnant, or more likely nowadays, a descending line.

Share prices from 1996:

2. Business

Without government bailouts, Credit Suisse managed to survive the subprime mortgage crisis with $904 million writedowns for its bond holdings and the same amount for their leveraged loans. Now, it is in the last phase of its three-year restructuring process. Cleaning risky loans and assets to avoid future regulatory issues, cutting jobs and decreasing operating expenses – that is the plan.

The bank has a history with regulatory fines and investors can hope that they can save a lot of money by not getting fines again. Credit Suisse has a business strategy called bancassurance: It has all the financial products for high net-worth and ultra-high net-worth clients. There is an emphasis on the wealth management division due to its high profit margins. It is concentrating mainly on the Swiss/EU and Asia Pacific market. China is one of the best-growing markets for wealth management and private banking companies.

The restructuring plan seems to be working well. The company has been constantly decreasing operation expenses while growing its assets in the last four years. This restructuring model has its costs – in the last three years, it had a negative net profit with decreasing revenues (and decreasing operational costs, too). However, this year the bank is going to make profit again.

Using Phil Fisher’s scuttlebutt method (the dumber and less deliberate, online version), Credit Suisse looks to be a good and open-minded, cosmopolitan workplace with great future career opportunities. At first glance, I wanted to write about Deutsche Bank (NYSE:DB) because of the low valuation – it seemed to be dirt cheap. After a careful consideration, I think that the German market is less profitable with a huge competition (Germany is overbanked) and greater risks. Switzerland looks much more stable and profitable regarding the banking industry.

a.) Average ROE levels of developed countries’ banking markets, source: Handelsblatt

3. Financials

Credit Suisse Ag

2018 Q1-Q3

2017

2016

2015

Shares outstanding(million)

2552,4

2550,3

2089,9

1951,5

EPS

0,69 CHF

(0,41 CHF)

(1,27 CHF)

(1,65 CHF)

Dividend/share

pending

0,25 CHF

0,70 CHF

0,70 CHF

Market cap. (USD billion)

28,4

45,63

29,91

42,46

Net revenues (CHF million)

16652

21786

21594

23286

Assets under management (CHF billion)

1405,3

1376,1

1251,1

1214,1

Total operating expenses (CHF million)

12557

17680

17960

22869

CET 1 ratio

12,9

13,5

13,5

14,3

Look-through Tier 1 leverage ratio

5,1

5,2

4,4

4,5

Number of employees

45560

46840

47170

48210

Credit Suisse made a profit this year, and the forward price-earnings ratio is 7.63. The common price-earnings ratio is not calculable due to past losses. The price-book ratio is currently at 0.66.

Keeping the operating costs low is crucial to be able to work efficiently in a volatile market – since 2015, the cost cuts reduced expenses by about 25-27%. The CET1 and Tier 1 ratios are eligible for future Swiss regulation laws. Historically, the company has paid a dividend annually. Currently, the trailing dividend yield is 2.35 %. Management plans to return 50% of profit by 2019 and 2020, using special dividends and share buybacks. So, the dividend is going to grow in the future. The first three quarters of 2018 revenues are growing, while the managed assets grew by 15.7% since 2015.

The number of shares also increased during the four years by about 30%. On the other hand, the average share price in 2015 was around $25. Monday, it is around $11. This is a 227% change since then.

In 2017, the revenue per employee ratio (calculates how much an employee generates for the company) was around $465,000. This is close to the same year’s revenue per employee ratios for Bank of America or Wells Fargo.

4. Management

Tidjane Thiam has been the CEO of Credit Suisse for three years now. He came from Prudential London – Credit Suisse could not groom its own banker for the office. Using Phil Fisher’s approach, this means that the bank had troubles with corporate governance.

Regardless, this is the last year of the restructuring plan. I reckon that he made it very well. The bank is constantly growing with good profit margins, lower operating costs and also generates new business. Europe has a troubled banking system; it could not recover from the credit crisis. Still, there are huge banks in big trouble in Europe. Now, management needs to earn investors’ trust again. The share buyback and special dividend plan to return 50% of the profit to the investors seem to be attractive.

Analysts say that while the wealth management margins are attractive, the investment bank margins at 15% are weak comparing to U.S.-based investment banks.

Overall, I think that Credit Suisse management has sucessfully restructured the bank and is doing its job well, but investors should persistently monitor the management’s activity.

5. Valuation

The average analyst price target for Credit Suisse is $18.94 and mostly, the recommendations are for a strong buy. It is very difficult to detachedly value such a large and diverse bank stock. The price hovering around $11.11 and the price-book ratio at 0.66 indicate that the stock is currently undervalued. Assume that a well-performing bank is worth a price-book ratio of around 1, but that may be too optimistic. So I reduced it by 10%. Now this is the price of a beaten-down bank stock that is still profitable and has a growing potential for the future.

Using Ben Graham’s principle of margin of safety, at price-book level of 0.66 you can buy this stock with 27% of margin of safety. That is buyin a dollar at 73 cents. And this is a pessimistic scenario.

Using GuruFocus’ projected FCF (free cash flow) for Credit Suisse, the price comes to around $61. This may be also delusive. The numbers are getting better while the stock price is getting close to historical lows.

6. Risks

Market downturns: The U.S. and EU markets are close to all-time highs. Maybe this is not the best time to buy stocks. There is a slight slowdown in growth regarding the U.S., EU and Switzerland markets. The increased volatility is due to global confrontations like the U.S.-China trade war. Credit Suisse concentrates on the Asia Pacific markets, but it is questionable, how they can compete with native companies.

Increased competition from another sectors: Today, innovative fintech startups and companies are considered a big risk to the established banking system. Many banks have outdated IT infrastructure and are averse from technological innovation. Disruptive technology may eat some banks’ lunch in the future.

Interest rates: They are currently negative at - 0.75. This is a double-edged sword. If interest rates rise, they will impact the business of Credit Suisse. The investment banking sector may experience a slight slowdown, while the wealth management division can do well.

7. Outlook

All in all, I am bullish on Credit Suisse. The bank is showing even better results and in the near future, it is going to raise dividends. If you buy a stock around $11, it will yield yearly 2.35%, which is going to climb up. At 70 cents yearly dividend per stock, the dividend yield rises to 6.36 %. That is why I think that it may be a great long-term investment.

Credit Suisse has just announced its disruptive technology recognition program. It will work with innovative fintech partners. Possibly, this may augment profit margins greatly. Hopefully, it is not too late.

With interest rate hikes, many companies will have a hard time. But banks may experience a boom, especially unpopular, beaten-down bank stocks with a healthy structure. Selling risky assets before an interest rate raise was a wise idea. Wealth management firms could heighten the fees regarding the safer investment assets, make higher returns on loans and boost profitability.

Disclosure: no position.

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