Why Is Deutsche Bank Valuation So Cheap?

Dan Kitwood

Deutsche Bank (NYSE:DB) continues to waste and acquisition astatine a discounted valuation that doesn’t look to beryllium warranted, but needs to execute its strategy and show nan marketplace that is sustainable profitability is now overmuch higher than it was successful the caller past.

I’ve analyzed Deutsche Bank several times successful nan past, but my past article connected nan slope was immoderate three years ago, frankincense I deliberation it’s now a bully clip to revisit its finance lawsuit to spot if its shares are undervalued correct now aliases if it remains a worth trap.

Over nan past fewer years, Deutsche Bank has been connected restructuring mode, executing connected its business strategy presented backmost successful 2019. While nan slope has improved its fundamentals and has reached a overmuch higher profitability than compared to immoderate years ago. Despite this background, Deutsche Bank shares proceed to waste and acquisition astatine 1 of the cheapest valuations successful nan European banking sector, measured by its price-to-book value ratio of astir 0.38x (vs. 0.83x connected mean for its closest peers).

As shown successful nan adjacent graph, Deutsche Bank’s valuation has not changed importantly complete nan past 5 years, pinch nan slope trading successful a comparatively constrictive scope of 0.2-0.5x book value, which tin beryllium considered a depressed valuation. Indeed, different banks pinch precocious vulnerability to finance banking activities, specified arsenic Morgan Stanley (MS) aliases Goldman Sachs (GS) waste and acquisition astatine a premium to book value, while European banks pinch a akin business floor plan to Deutsche Bank waste and acquisition betwixt 0.5x-0.7x book value. The only objection is Credit Suisse (CS), which is presently trading astatine only 0.24x book worth owed to immoderate circumstantial issues.

Valuation (Bloomberg)

This inexpensive valuation tin either mean that DB banal is presently undervalued by nan market, which continues to worth it unfairly for illustration a debased value bank, aliases location are still immoderate circumstantial basal issues to hole that nan marketplace is worried about.

Business Strategy

Deutsche Bank presented its past strategy update backmost successful December 2019, aiming to amended nan operating capacity of nan slope by scaling backmost from unprofitable activities, trim its vulnerability to finance banking and turn different segments of nan bank, specified arsenic firm and backstage banking, positive amended profitability mostly by costs cutting. In nan adjacent graph, it is represented nan bank’s planned measures astatine nan extremity of 2019, to execute its return connected tangible equity (RoTE) ratio of 8% by 2022.

RoTE (Deutsche Bank)

As tin beryllium seen, astir of its planned profitability betterment was expected to beryllium achieved done costs cutting, which is wrong nan bank’s control, while gross maturation was not expected to beryllium a immense contributor. This was a sensible strategy because gross maturation is mostly extracurricular of management’s control, arsenic it depends mostly connected liking rates and customer’s activity levels, frankincense a strategy based connected costs cutting was much apt to beryllium ‘accepted’ by nan market.

To trim its yearly expenses to astir €17 cardinal by 2022, Deutsche Bank planned immoderate 18,000 unit reductions, pinch nan immense mostly being planned successful nan finance banking division. However, of these planned reductions, really only astir 8,000 were executed complete nan past 3 years, arsenic gross maturation successful its finance banking (IB) conception was higher than expected.

Indeed, while Deutsche Bank’s strategy was to trim its vulnerability to IB, this section accounted for astir 37% of full gross successful 2022, remaining nan bank’s largest segment, while successful 2019 this section accounted for immoderate 29% of its full revenue. This summation is justified by overmuch amended operating capacity successful activities related to superior markets successful 2020 and 2021, which led to yearly gross maturation of astir 7% complete nan past 3 years, being its awesome maturation engine, while successful 2019 it was expected CAGR of only 2% successful this unit.

Moreover, arsenic liking rates besides accrued astatine a higher gait successful nan past 12 months than expected successful 2019, its backstage and firm banking segments achieved higher gross maturation than expected, starring Deutsche Bank to make immoderate €27.2 cardinal successful gross during 2022. This was supra its extremity of astir €25 cardinal group 3 years ago, moreover though pinch a different operation than nan slope was planning.

Revenue (Deutsche Bank)

While gross was rather beardown complete nan past 3 years and hit estimates respective times during this period, connected nan different manus nan bank’s way grounds connected costs cutting was not impressive. While Deutsche Bank was targeting yearly expenses of astir €17 cardinal successful 2022, it reported expenses of €19.9 billion. This is 17% supra its target, which is explained, astatine slightest successful part, by higher gross maturation than expected and nan slope didn’t want to extremity affirmative operating momentum successful its finance banking.

Nevertheless, by missing its costs cutting target, Deutsche Bank besides missed its ratio ratio, arsenic nan slope was targeting a cost-to-income ratio of 70%, while it reported an ratio ratio of 75% successful nan past year.

Cost to income ratio (Deutsche Bank)

While this is simply a clear betterment from very mediocre ratio levels reported successful nan erstwhile 4 years, Deutsche Bank is still 1 of nan slightest businesslike banks wrong its closest peers, pinch nan objection of Credit Suisse that has reported very mediocre metrics successful nan past mates of years (cost-to-income ratio supra 100%). Without considering Credit Suisse, nan mean ratio level of its peers was adjacent to 69% successful 2022, showing that Deutsche Bank still has immoderate activity to do regarding its efficiency.

Despite not achieving its desired ratio level, Deutsche Bank’s higher gross than expected was capable for nan slope to amended its profitability successful a meaningful way. Its RoTE was 9.4% successful 2022, supra its 8% target defined successful 2019, and it was nan highest profitability level since 2011.

Group RoTE (Deutsche Bank)

Beyond an improved operating floor plan and higher profitability, Deutsche Bank besides maintained a bully superior position complete nan past fewer years and a blimpish indebtedness book profile, which is simply a beardown backdrop for a imaginable economical recession successful nan coming quarters. At nan extremity of 2022, its halfway equity tier 1 ratio was 13.4%, which is simply a bully level, and not overmuch different from what it was immoderate years ago, showing that superior was not an rumor erstwhile it presented its strategy backmost successful 2019.

Capital (Deutsche Bank)

These improved fundamentals and profitability person enabled Deutsche Bank to resume dividend payments and share buybacks successful nan past year, while successful nan erstwhile mates of years it had suspended superior returns to shareholders. This is different affirmative motion that its restructuring programme was successful, moreover though superior returns were comparatively small, but is simply a affirmative measurement and Deutsche Bank tin now displacement its attraction from business overhaul to supply an improved shareholder remuneration policy.

Going forward, nan slope is expected to update its business strategy astatine nan opening of adjacent month, but its strategy and goals shouldn’t beryllium overmuch different from what nan slope has been communicating, namely proceed to summation profitability by achieving immoderate gross maturation and costs cutting, and administer a bully portion of its net to shareholders complete nan coming years.

2025 targets (Deutsche Bank)

Valuation

While nan slope has intelligibly improved its fundamentals complete caller years, and its early business prospects are stronger than successful nan past, its shares proceed to waste and acquisition astatine a important discount to its closest peers and nan mean of nan European banking sector.

I deliberation this happens because aft truthful galore years of mediocre profitability and costs owed to past misconduct, investors proceed to beryllium skeptical astir Deutsche Bank’s sustainable net successful nan future. The truth that Deutsche Bank achieved its financial targets group successful 2019 done a different way than planned besides doesn’t help, particularly regarding costs cutting, an area wherever it has intelligibly grounded to scope its target.

Moreover, nan use of higher liking rates whitethorn beryllium impermanent fixed that nan existent hiking gait from nan European Central Bank (ECB) is not definite to proceed complete nan coming months. Market expectations are for a fewer much hikes successful nan short term, but pinch ostentation already decelerating and nan anticipation of a recession successful Europe ahead, nan marketplace is expecting nan deposit complaint (currently astatine 2.5%) to highest astatine 3.5% by mid-2023, and enactment astatine that level thereafter.

Interest Rates (Bloomberg)

This intends that Deutsche Bank should proceed to use from higher liking rates complete nan coming 3 aliases 4 quarters, but further gains aft that whitethorn beryllium difficult to achieve. With economical activity slowing down and individuals and corporates being squeezed by rising borrowing and power costs, default rates are apt to spell up successful nan short word starring to higher loan-loss provisions, impacting negatively nan bank’s bottom-line.

Taking into relationship this background, it is not astonishing to spot that thoroughfare estimates are somewhat downbeat, fixed that Deutsche Bank’s gross is expected to beryllium €28 cardinal successful 2023 (+2.9% YoY) and €28.7 cardinal successful 2024 (+2.5% YoY), while its nett income is expected to beryllium €4.17 cardinal (-17% YoY) successful 2023 and €4.7 cardinal successful 2024 (-6.5% vs. 2022). Due to little net expected complete nan adjacent mates of years, its return connected equity (ROE) ratio is expected to beryllium 6.4% successful 2023 and 7.1% successful 2024 (vs. 8.4% successful 2022).

Therefore, 2022 is expected to beryllium an outlier twelvemonth regarding profitability, and considering marketplace estimates for nan adjacent 2 years, its mean ROE for nan play 2021-25 is only 5.1%. Note that I’m not counting 2019 and 2020, which were very anemic years for nan slope and would alteration moreover further its mean ROE.

Using nan Gordon maturation exemplary to worth its shares, and assuming a costs of equity of 11% and ROE of 5.1%, its deserved P/BV aggregate is 0.36x. This is in-line pinch Deutsche Bank’s existent valuation, showing that Deutsche Bank’s discounted valuation is warranted.

However, arsenic business prospects person improved and nan slope is apt to study a higher ROE successful nan adjacent early than compared to its history, assuming a ROE of 7.3% (its mean during 2022-25E), this yields a deserved P/BV ratio of 0.58x. This would lead to a adjacent worth supra €17 per share, aliases an upside imaginable of adjacent to 50% compared to its existent stock price.

Conclusion

Deutsche Bank is 1 of nan cheapest banks wrong nan European banking sector, and compared to its finance banking adjacent group, a valuation that is justified by its humanities performance, but not by its imaginable ‘sustainable’ profitability successful nan adjacent future.

If nan slope tin summation nan market’s assurance successful its business prospects, its shares look to beryllium undervalued, while downside astatine existent levels appears to beryllium debased astatine its discounted valuation, making it a bully worth play wrong nan banking assemblage correct now.

Labutes IR is an Fund Manager specialized successful nan financial sector, pinch much than 15 years' of acquisition successful nan financial markets. Under my sum is chiefly nan Financial sector, including Banks, Insurance, Real Estate and FinTechs some successful nan European and U.S. markets. For my individual investments I besides put successful 'Income' stocks, arsenic I'm building a portfolio for retirement, pinch nan extremity of being capable to discontinue successful 20 years.