Millennium BCP (BCP:LIS)

Millennium BCP is the second biggest bank in Portugal with over ~18% and ~17.5% share of loans and customer deposits respectively. More than 72% of its assets are Portugal based, with the rest located principally in Poland, Angola and Mozambique. Like most European banks, and Southern European banks in particular, it has had a torrid few years, with concerns over capital adequacy due to mounting debt and NPLs. It has not yet managed to recover from two bank rescues by the state in 2014 and 2015 and concerns continue to exist over capital levels and risk of big write downs in future owing to NPLs. In spite of undergoing major capital increases in 2012, 2014 and 2015, its shares are down by ~65% year to date, and currently trade at ~26% Tangible Book Value (TBV).

Key Stats

Investment case

I believe that BCP’s share price is at or close to its trough and at ~26% TBV offers good upside potential with decent downside protection. My investment case is built on the following indicators:

Profitability showing a positive trend - Pre-Provision income has stabilised, with net interest income showing an upward trend; the bank made €850m in operating profits for the 9 months to Sep16 and average pre-provision income for the last 4Qtrs has been €256m. I forecast the bank to make just over €1000 in pre-provision income for FY17.

One of the best Cost to income ratios among peers - The bank has done a commendable job in controlling costs, with cost to income ratio having fallen from 85% to 50% between 2013 and 2016. Cost to net operating revenues has average 48.5% over the last 4 Qtrs.

NPLs showing downward trend with robust coverage at 99% - NPE’s have consistently shown a downward trend, having fallen from €12,783m in Dec13 to €9,257 in Sep 16 (a fall of 27.6%). NPE’s currently stand at 18% of gross loans and have a robust coverage ratio of 99% due to the bank having taken some hefty provisions of late. I believe that the bank must be applauded for such robust provisioning and the 99% coverage provides comfort on future earnings bar a disastrous spike in NPEs and provisions. The made a €251m net loss for the 9 months to Sep 2016 of the back of hefty impairments and provisions to bring the coverage ratio to 99% (this in spite of having made €850m in pre-provision income). Commenting on the hefty impairment and provision charge, CEO Nuno Amado said 2016 was "absolutely unusual in terms of impairments", which should not happen again.

The other key metric I look for in a distressed bank is the trend in loans overdue for more than 90 days. For BCP, this shows a downward trend with robust coverage.

Overall trend in NPEs and total coverage in the banks's Portuguese business

Positive trend in other KPIs – Other Key Performance Indicators showing a positive trend with net loans as a percentage of customer funds standing at 97%; ECB funding usage down by a billion to €4.9bln against prior year comparable period; and number of customers showing a solid 6% growth in the 9 month to Sep16 and now standing at 5.4 million.

Portuguese economy showing positive signs – After years of painful structural reforms, the Portuguese economy has been showing positive GDP growth since FY14 (with GDP growth projected at 1.4% for FY16); unemployment is expected to fall to 11.4% in FY16 compared to the height of 16.8% in FY12; and current account balance as a % of GDP has been positive for the past few years.

Valuation

I forecast FY17 pre-provision income of €1,022m. Net income will largely depend on the level of impairment and provisions, but given the robust 99% coverage ratio and significant impairments booked in current and prior years, I believe that net income should be in the range of €206m to €343m, giving a Forecast ROA in the range of 0.28% to 0.47%.

European banks current trade at average Price to Earnings ratio of 10.5x and Price to Book of 0.77x. Even allowing a 20% - 30% knock down in the PE ratio for BCP (for the more risky south European bank), I get a per share value of €2.23 for an 80% return to current share price.

Other matters

Forsun’s investment – The Chinese conglomerate Forsun has offered to buy new equity in the bank amounting to a 16.7% stake at current price (plus a potential premium). This should rise additional ~€189m of equity and add a long-term investor to the share register. Forsun has further expressed interest in increasing its stake to 30% though secondary market purchases (or in the event of capital increases). Although I don’t know much about Forsun – other than the fact that it has been a hyper active acquirer of late – overall, this investment could be taken as a positive sign.

€750m of bonds due for repayment - The bank has expressed its intention to repay the €750m of contingent convertible bonds due to the Portuguese State by June 2017. Given the current trend in operating profits, including the Forsun cash, I believe that this should be easily achievable bar a disastrous happenstance with NPE’s or impairments.

Conclusion

With its positive trend in operating profits, downward trend in NPEs combined with a robust coverage ratio at 99% of NPEs, and with decent uptick in Portuguese macroeconomic indicators, shares in BCP, which currently trade at a cheap 26% of TBV, offer a good upside potential. Bar a disastrous rise in NPEs and impairments, downside appears to be limited.