Summary

• Santander is one of the largest banks in the Eurozone with EUR 1508 B in assets and a significant exposure to Americas, particularly Brazil.
• Covid – 19 disrupted dividend’s steady growth but the company expects to restore cash payments of up to 50% of underlying profits when conditions normalize.
• In 2020 revenue was down more than 10% and the bank reported huge loss due to goodwill’s negative adjustment. The bank is heavily dependent on net interest income which remains under pressure in a low interest rate environment. Increasing interest rates would be a tailwind for the bank.
• The quality of credit portfolio is good and improving further. The bank’s CET1 ratio is safe 12.3%.
• There is moderate stock appreciation potential under the stock evaluation method based on historical P/E ratio.

Dividend    Revenue    Profitability    Financial Strength    Investment Case

Santander (SAN) is one of the largest banks in the Eurozone with 10K branches worldwide. It has 148 M customers – individuals, SMEs and large corporates – and is involved in all types of banking activity, making it a one-stop shop for customers. The company has an ambition to become the best open digital financial services platform. During the pandemic it accelerated digital transformation and 44% of sales in 2020 were digital versus 36% in 2019.

Santander has five primary reportable segments: 4 operating areas and the Corporate Centre. Operating areas are Europe, North America, South America and Santander Global Platform (global digital services). At the secondary level the Group is structured into Retail Banking, Santander Corporate & Investment Banking (SCIB), Wealth Management & Insurance (WM&I) and Santander Global Platform.

The bank’s exposure to Americas is significant.

In 2020 the company launched three strategic initiatives:

• One Santander – to create a new operating model in order to simplify its mass market value proposition, implement omnichannel strategy and create regional operating centers with shared technology platforms.
• Digital Consumer Bank – to build a global digital consumer lender using the technology of Openbank digital platform and the scale of Santander Consumer Finance in Europe.
• PagoNxt – to combine payments businesses into a single, autonomous company.

    Dividend

Dividend	Dividend Yield	5Y Growth	PayOut Ratio
EUR 0.0275 per share	0.88%	-33% per year	55% in 2019

Due to the pandemic related challenges the European Central Bank (ECB) recommended banks to suspend dividend payments until economic conditions normalize. So Santander cancelled the final dividend for 2019. Then dividend payments were resumed in autumn with a dividend for the equivalent of EUR 0.10 in newly issued shares for 2019. That has led to the increase of 0.72 B of total number of shares of the company. Total dividend for 2019 amounted to 0.20 per share (EUR 0.23 in 2018). In respect of 2020 a cash dividend of EUR 0.0275 per share was paid. For 2021 dividend payments would depend on ECB recommendations.  Over the mid – term the company intends to restore a payout ratio of 40% – 50% of underlying profit. For now dividend is not covered by earnings as last year’s earnings are negative.

In the pre – Covid years the bank’s dividend has been in a steady uptrend. In the coming years we could expect that Santander resumes its annual payouts at the same level as in 2019 and adds to it 1 cent each year, as in the past years.

  Revenue

Revenue	5Y Growth	Revenue growth over 2020	Company Outlook 2021
EUR 44.28 B	-0.44% p. a.	Total sales                     -10.3% By divisions: Europe                            -6.2% North America              -5% South America             -19%, but +5%, excl. forex	A moderate increase in lending and a good performance in deposits.

The pandemic has led to weaker economies and low interest rates around world. These together with changes in exchange rates all have negative impact on the revenue last year. It was EUR 44.3 B, down more than 10% (in 2019 was EUR 49.2 B). Net interest income (NII) and net fee income (NFI) accounted for 95% of total income. NII was 9% lower and NFI 15% lower while investment income 43% higher than in 2019. The relative strength of Euro against other currencies has had particularly negative impact on the revenue. Excluding the impact of changes in forex rates, total revenue is almost the same as in 2019. The bulk of revenue is interest income. That makes the bank heavily dependent on interest margins.

SCIB and WM&I divisions performance was strong in 2020: the revenue has increased and accounted for 46% of the total net fee income. Traditional lending, excluding forex rates effect, rose 5% (Europe +4%, North America +2% and South America +15%) and customer deposits were 3% higher over the year.

In 2021 Santander expects a moderate increase in lending and a good performance in deposits in all core markets. In the first half of 2021 net interest income is EUR 16.2 B, almost the same as a year ago and total income, EUR 22.7 B, 2% higher than last year. The loan growth was also 2%.

In 2021 the bank expects the following developments in regions:

• In Europe – to create Regional Business Owners, leverage global businesses (SCIB & WM&I) and the connection with PagoNxt to accelerate profitable growth; also to deliver cost savings according to the plan of EUR 1B cost savings within the next two years.
• In North America – to consolidate regional IT under a single leadership and optimize expenses.
• In South America – to implement digital transformation and maintain the strong growth of loyal and digital customers.

  Profitability

Profit	5Y Growth	Net Profit Margin	ROE
EPS EUR -0.54, EUR 0.35 in 2019 Net Profit EUR -8.77 B	N/A	-17.4% in 2020 16.5% in 2019	-8.4%

Santander has generated resilient profits throughout all stages of business cycle.

Due to the weaker economy the goodwill was negatively adjusted by EUR 10.1 B resulting in huge loss of EUR 8.77 B. However that adjustment has no impact on the capital ratios of the bank. The pandemic related loan loss provisions have not been high compared to a loan book. So underlying profit, calculated excluding goodwill adjustment and other one-off costs, is 38% lower over the year. That was possible due to lower operating expenses. Since the start of the pandemic the company implemented additional savings measures to reduce costs. Operating expenses were 9% lower over the year (1%, excluding forex impact). Santander is one of the most efficient banks in the world with an efficiency ratio of 47% (efficiency ratio is cost – to – income ratio). The bank’s funding costs are low as it has strong customer deposit portfolio dominated by current deposits. Global businesses, SCIB and WM&I, are highly profitable and they account for 38% of profit.

In the first half of 2021 EPS was EUR 0.197 versus the loss of EUR 0.64 a year ago due to lower loss provisions. Underlying EPS is up 141%. Over the mid – term period we could expect that EPS is back to the average value over the pre – pandemic years, EUR 0.4.

  Financial Strength

In EUR B

Year	2019	2020	1HY
Equity	110.66	91.322	95.745
Debt	269.796	240.084	302.67
Debt/Equity	244%	263%	316%

Santander’s Debt -to- Equity (316%) and Asset -to- Equity (16.4x) ratios are moderate. Loans -to- Assets (61%) and Loans -to- Deposits (107%) are also appropriate.

A bank’s financial strength depends significantly on the quality of its credit portfolio. Santander has non – performing loans ratio of 3.21% and coverage ratio (allowance for bad loans) of 76%, both improved over the year. However the cost of credit was up from 1% to 1.28%.

Santander aims to have a CET1 ratio of 11% – 12% in the medium term. At the end of 2020 it was 12.3%. So it is comfortably above the minimum level of 8.85% required by ECB.

  Investment Case

The estimate of future stock price and investment returns based on P/E ratio

Assumptions of dividend and EPS growth over the next 5 years
We assume that dividend is restored to EUR 0.2 and grow by cent 1 per year thereafter. So the total dividend income over the next 5 years would amount to EUR 1.10. We assume EPS in 5 years to be EUR 0.4 per share.
Projected stock price
Average P/E over the last 5 years (9.18) multiplied by EPS in 5 years = 9.18 x EUR 0.4 = EUR 3.67.
Future Returns Based on the Assumptions
Stock price upside potential                                       12.6%    from the current price of EUR 3.26. Overall return on investment*                                     46% Compound Annual Return on Investment                 8%

*- Includes the expected dividend income over the next 5 years and dividends are not reinvested.

Santander has a diversified portfolio, both by product and geography. It has exposure to both developed and emerging markets. As a result underlying revenue exposed strong resilience in the pandemic hit environment. On the other hand Latin American economies are more volatile than developed ones. Also there is a risk that more loan loss provisions would be needed to deal with consequences of the pandemic. Successful cost cutting, measures to boost revenue and rising interest rates should improve the bank’s performance. High dependence on interest income could become a real tailwind if interest rates go up. Once dividend is restored investors could expect growing dividend income and the stock price appreciation in the future.

 

Disclosure:

I am long SAN

Notes

Data source – the company’s financial reports and presentations. Source of pictures – the company website unless otherwise stated. Colored circles next to headings mean an author’s evaluation of the relevant performance criteria of the company: green means positive, yellow neutral and red negative evaluation. There are many ways to estimate the future stock price. We use only one of them, the one based on P/E ratio. All estimates made in the article are for the informational purposes only. No taxation, brokerage fees and other expenses related to investing are considered in the estimates. The estimates are the result of the rule of thumb assumptions and the real outcome might differ materially from those estimates. As the future unfolds, macro events, not mentioned in the article, could impact the company fundamentals. Use the information in the article only as a starting point for your own due diligence.