Banco Santander Brasil (NYSE:BSBR) reported earnings today. After the challenges of 2022 and 2023, results continued to show improvement across most fronts.
This article covers the company’s 2Q24 results and earnings call. It also introduces the company from my perspective, and my thesis on its main competition challenges. Overall, I believe the stock is an opportunity at these prices, given the expected earnings and growth yields of the company.
Small intro
The younger brother of the big five: Santander Brasil is one of the five largest banks in the country (Banco do Brasil, Itau, Bradesco, Caixa, and Santander). It is the youngest of the group and the one with the worst long-term ROE prospects. Still, the bank has carved itself a space in affluent retail and in auto loans.
Post-pandemic credit cycle: After the pandemic, the Brazilian Central Bank drove interest rates down to close to zero. This, coupled with increasing digitalization, led to significant credit expansion. When inflation started to tick, the BCB moved rates fast to above 10%, leading to a significant increase in NPLs for banks. Santander was one of the most damaged ones.
Today, the bank is recovering from that process thanks to more normalized rates. In my opinion, this cycle will continue, independently of rates decreasing more, because what drives NPLs is not so much high rates, but rather high volatility in rates.
Competition from neo-banks: Santander’s bears also argue that the bank is challenged by neo-banks like Nu Holdings (NU) and Inter (INTR). These banks are strong in mass market retail, and growing fast. The thesis is that they will remove the profitable retail business (especially the service areas like credit card frees) from the large banks.
I do not believe this thesis is correct for two reasons. First, it is true that retail clients are the most profitable for banks, but to serve them, banks also need to have strong business banking arms to get deposits. The neo-banks have not started inroads in business banking. The second reason is that neo-banks are good at simple service and mass-market retail, which is not the most profitable subsegment of retail. Serving premium retail requires more lending capacity, especially in areas like mortgage, auto and payroll, that the neo-banks lack. Also, gaining principality with affluent retail requires trust that is difficult to build for neo-banks because they do not have physical locations.
2Q24 results show continued improvement
The company’s 2Q24 results posted continued improvement across most lines of business.
Santander’s loan book was up 8%, thanks to continued monetization of the Brazilian economy. NPLs were down YoY, thanks to the normalization in rates. Margins, on the other hand, were resilient, thanks to a generally cautious position from banks and stable rates again. The result was net interest income expanding by 10% YoY.
The bank also performed well on the service and cost front. In the past year, it has closed 14% of its locations and 25% of ATMs (as Brazil’s currency is increasingly digitalized). On the other hand, service revenue grew close to 20%, compared with expenses of only 4%, thanks to increasing penetration of cards in affluent retail and higher credit activities. This led the efficiency ratio down close to 4 percentage points, to below 40%, an adequate level for a bank.
The improvement in operations is marked, with net income and EPS up 50% YoY, and return on average equity up 4 percentage points, to 15.5%, a level that would be considered high in the US but is average in Brazil (a country with a profitable banking industry).
In terms of business developments, the most important development of the quarter was the launch of a free account and credit card service for mass retail. This segment is not very profitable for banks, but launching a free service hits the neo-banks in their core market. This will make them less willing to fight in the upper segments.
Valuation is attractive
I believe the market continues to reject Santander for two reasons. One is the competition from neo-banks. As explained above, I do not think that thesis is correct. The second is the depreciation of the Brazilian real, which drives down the value of a Brazilian bank and profits in dollars. Against this, one can only ask for a higher return from the stock to cover this risk, because trying to predict where foreign exchange rates are going is extremely hard.
At annualized income, Santander is potentially going to generate more than BRL 13 billion in net income in FY24. Against these, the company trades at a market cap of $18.2 billion, or BRL 102 billion. This represents a 12% current earnings yield.
On top of this, the bank is probably not going to continue driving margin improvements, given that rates have already stabilized, and that NPLs have remained flattish in the past few quarters. This means that growth has to come from monetization (expansion of credit). Brazil is expected to grow real GDP by 2% this year, with inflation at 4%, leading to nominal growth of 6%. In addition, given the recent depreciation of the BRL, monetization will probably increase. This should easily allow Santander to grow at 6% or more. If we look at the past 10 years (during which Brazil suffered a decade-long recession), the bank still grew above 8% (from BRL 520 billion in assets in 2014 to BRL 1.3 trillion today).
Adding the normalized growth rate to the current earnings yield provides a yield of 20% for the bank. In addition, the credit cycle in Brazil could continue to improve, as it is now only normalized. This could lead to a stock rerating for Santander. This, in my opinion, seems more than enough to justify the risk of continued pressure against the BRL, and of a deterioration of the credit cycle in Brazil.
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