Equity Research; EU Focus List

The EU rolls on…

EU assets were marked up with the election of Emmanuelle Macron as President of France. This marks the third time, (Austria, Holland, France) that centrist leaders have won EU elections – a clear rejection of anti-EU/ populist / nationalist tendencies in evidence in 2016.

French shares (as measured by the CAC 40) jumped 11.7% from New Year’s Eve 2016 to May 5th (the last closing day before the election) 2017. Dutch shares (as measured by the AEX) gained 5.9% from New Year’s Eve 2016 to the March 15th election. Maybe in 2016 investors had overpriced the risk of an EU political maverick?

I was in South Kensington on the 7th May (at my local gym). I can report there were significant queues outside Lycee Charles de Gaulle, the voting station for London based French voters. It was obvious that a lot of determined people were there to ensure the right person was elected. There was no ambivalence in the air at all. The Russians left hacking the Macron campaign’s emails a bit too late! The landslide result of 66% was the highest endorsement in modern times of a politician backing the EU project.

The vote also reflects a vote of confidence in EU institutions. The Le Pen vote started to collapse during the televised debate when she started talking about the French franc. This betrayed a surprising ignorance of socio-economic affairs. Less than 22% of the French voting population think the franc should return. There is widespread confidence in the ECB.

UK commentators are quick to denigrate the EU. The experience of Croatia since it joined the EU has never got a mention in UK tabloids, for good reason. Over 66% of Croatians voted for EU accession in 2012. When Croatia joined the EU, (on the 1st July 2013) its economy was in recession. But Croatia’s president threw a party, proclaiming “a new chapter in the thick book of our history”. Helped by EU tourism and improving exports the Croatian economy has seen significant GDP growth since EU membership, well ahead of its performance prior to entry.

When 2017 started, there was understandable nervousness over EU elections. With political factors diminishing (the German elections in September are not a concern) we provide our top three EU blue chip picks.

BNP Paribas SA – BUY

French banking giant, BNP Paribas has a significant global footprint with on & off balance sheet commitments of €1.43trn. Its lending activities are spread amongst developed countries, France (27%), North America (15%), Other EU (15%), Belgium & Luxembourg (14%), Italy (14%), Asia (8%), Rest of world (7%) and UK (4%).

BNP Paribas is split between a) Domestic markets (DM) b) International Financial Services (IFS) c) Corporate & Institutional Banking (CIB) with allocated equity broadly one third in each. This is a significant differentiating factor for EU banks which tend to be more retail banking/ consumer credit focused.

The major theme in modern banking is digitization – the move to secure banking online/ mobile operations and away from physical locations/ staff has been underway at BNP since 2012. BNP has reduced its branch network substantially in Germany (785 branches- 153), France (1964 branches – 236), Italy (787 branches -103).

BNP net book value ended 2016 at €73.90 (TNAV €63.30) after reporting net income of €7.7bn, a return on tangible equity of 11.1%- this is high relative to EU peers.

BNP plans to increase its payout ratio to 50% by 2020 from the current 45% level – BNP paid €2.70 per share in respect of FY2016 v €1.20 in FY11 an annualized 5 YR growth rate of 17%.

Consensus profit estimates; BNP Paribas SA
Year End Revenue (€bn) Net Inc (€bn) EPS (€) DPS (€) P/E (x) Yield (%) Share Price (€)
Dec-16 43.4 7.7 6.00 2.70 11.1 4.03 67
Dec-17 43.7 7.3 5.70 2.85 11.7 4.25
Dec-18 44.8 7.6 6.00 3.00 11.1 4.48
Dec-19 46.2 8.4 6.80 3.30 9.8 4.93

Source: www.zonebourse.com

Consensus forecasts envisage improving profits in 2018/2019 leading to BNP reaching its 50% payout objective in 2018.

Company BNP

Key Catalysts

BNP’s solid Q1 read (net income €1.89bn+ 4.4%) was due to far lower exceptional items (€76m v €208m) and lower costs of of risk (€592m v €757m).

The improved positioning in CIB (revenue +20%) and DM suggests an improving 2017 outlook for EU corporate activity.

A modest 3.4% premium to tangible net assets (€64.80) and rising CET1 ratio (11.6% +0.15% since 2016) gives confidence in the dividend outlook.

BNP is a beneficiary of higher US interest rates, expected over 2017.

Share Price €67.00
Target Price €80.00
52 Week Hi/Low €68.40/ €35.27
5 YR Hi/ Low €68.40/ €26.23
Shares O/S 1.247bn
Market Capitalisation €83.5bn
Avg. Daily Volume 1.86m
Dividend Yield 4.35%+

Source: www.zonebourse.com

Key Risks to Price Target

  1. A downgrade to BNP current credit rating of A+ (S&P) would impact BNP’s cost of funds and net interest margins.
  2. Risk of deterioration in credit metrics, and higher credit losses at BNL BC – BNP’s Italian subsidiary
  3. Profits are sensitive to BNP Global markets division where trading volumes and M&A activity is variable.

Bollore SA – BUY

Bollore, formerly Bollore Technologies is a diversified French conglomerate with interests in transport & logistics, communication & media and electricity storage alongside a €4.5bn investment portfolio including a 20.4% stake in Vivendi, 7.9% of Mediobanca and 38.9% of SocFin (one of the world’s largest plantation owners) alongside substantial port / railway interests in Africa. Bollore has 18 port concessions in Africa and is in the top ten bracket for global freight forwarding (no 1 French domestic fuel distributor).

The Chairman/ CEO, Vincent Bollore has transformed the business since taking it over in 1981 turning it from his family’s paper business in to a Fortune 500 company. He is one of France’s wealthiest individuals. He is a well known corporate raider typically taking small stakes in companies but securing significant voting rights in the process.

The 2016 result; turnover €10.07bn (-7%), net income €588m (-19%) EPS 15 cents -23% was impacted by a weaker result in Bollore transportation & logistics where turnover fell 10% due to lower oil and commodity prices. Bollore’s investment portfolio declined by €424m to €4.55bn in 2016.

Bollore has an outstanding track record of delivering investor returns, rising 7.5x (fold) since 2004. Bollore issued a 5 year bond in January – the subscription level reached €2bn, four times its €500m size.

Consensus profit estimates; Bollore SA
Year End Revenue (€bn) Net Inc (€bn) EPS (cts) DPS (cts) P/E (x) Yield (%) Share Price (€)
Dec-16 10.07 0.444 15 6 26.1 1.53 3.92
Dec-17 10.31 0.390 16 8 24.5 2.04
Dec-18 10.63 0.466 16 8 24.5 2.04
Dec-19 10.93 0.546 21 8 18.7 2.04

Source: www.zonebourse.com

The consensus forecasts suggest EPS growth will stall over 2017 and 2018 whilst moving up sharply in 2019.

Company BOL

Key Catalysts

Looking at 2017 there are a number of initiatives in the mix:-

a) Recent tender offer Blue Solutions suggests further investment in LMP initiatives

b) Vivendi shareholding >20% with voting rights now c .29% – Bollore has launched a €300m savings plan to return Vivendi to break-even by 2019 -the pay-TV unit might then be sold to Sky/ Liberty Global.

c) Recent investments in port infrastructure are likely to positively impact revenues of $4.1bn.

Share Price €3.92
Target Price €4.75
52 Week Hi/ Low €3.73/ €2.82
5 YR Hi/ Low €5.13/ €1.58
Shares O/S 2.9bn
Market Capitalisation €11.39bn
Avg. Daily Volume 2.5m
Dividend Yield 1.53%+

Source: Fidessa plc

Key Risks to Price Target

  1. Sensitivity to executive changes / dependence on Vincent Bollore leadership
  2. Exposure to soft crude oil prices which impacts demand for oil logistics services
  3. Financiere de l’Odet holds 64.4% of Bollore hence low free float.
  4. Recent investigation over West Africa port contracts might result in legal developments.

Munich Re – BUY

Munich Re is a leading global reinsurer (reinsurance is the insurance risk that insurance companies do not want). Reinsurers provide underwriting to “large cat” (“large catastrophes”) risks i.e. tsunamis, hurricanes, floods, earthquakes and other Act of God type large difficult to quantify insurance claims. In addition, Munich Re owns Ergo, a direct insurer covering life, healthcare and property insurance.

Munich Re has a substantial €235bn investment portfolio (this is mainly client/ policyholders’ money) managed by Munich Re’s internal fund management arm, MEAG.

The board reported Q1 net profit of €557m with shareholder’s equity up 1.2% over the quarter to €32.1bn. The combined ratio stood at 97.1% (i.e. 2.9% underwriting profit) during Q1 2017 an improvement from 101.9% in Q4 2016. The guidance for 2017 was unchanged, the board expect €49bn of premium income with net profits of c. €2.2bn.

The share buyback scheme in place since 2006 has seen Munich Re repurchase 74.55m shares paying shareholders a total of €10bn. The shares in issue has reduced from 229.6m to 161m. Over the last decade Munich Re has lifted its dividend from €4.50 to €8.60 per share.

Consensus profit estimates; Munich Re AG
Year End Revenue (€bn) Net Inc (€bn) EPS (€) DPS (€) P/E (x) Yield (%) Share Price (€)
Dec-16 48.85 2.58 16.1 8.60 11.1 4.85 177.14
Dec-17 51.47 2.37 15.2 8.75 11.8 4.94
Dec-18 52.24 2.40 16.1 9.05 11.2 5.11
Dec-19 52.80 2.42 17.3 9.37 10.4 5.29

Source: www.zonebourse.com

The consensus forecast suggests earnings growth over 2017/2019 with a generous dividend yield. Munich Re profits are sensitive to natural disasters and environmental changes.

Company Munich Re

Key Catalysts

A tough round at the April reinsurance renewals (-9.2%) and an average Q1 has led to a share sell off from €189 (26th April) to €177. The share decline has created a discount to net assets (€199.80 per share) of around 11.4% – a high level for Munich Re.

But 2017 has started well from a claims viewpoint, ahead of the critical US hurricane season. Q1 has seen rising bond prices which will boost investment returns.

The €1bn share buyback program will buyback 11m Munich Re shares in 2017. We expect share buybacks to continue.

 

Share Price €177
Target Price €200
52 Week Hi/Low €183.4/ €145.1
5 YR Hi/ Low €205.3/ €95.85
Shares O/S 161m
Market Capitalisation €28.5bn
Avg. Daily Volume 241k
Dividend Yield 4.86%*

Source: Fidessa plc

Key Risks to Price Target

  1. High liquidity in global capital markets, due to low interest rates, creates high liquidity in insurance markets, increasing the risk of insurance overcapacity and lower insurance premiums.
  2. Munich Re profit is sensitive to reinsurance underwriting profits (c.90% of total)
  3. Sensitive to “large cat” risks i.e. tsunamis in high insurance density areas such as Japan & “hurricane season” in Florida.
  4. Sensitive to insurance renewals at lower prices than previous years

(NB. “PBT”- profit before tax, “EPS” earnings per share, “DPS” dividend per share, “P/E” price to earnings)

(NB. *German dividends in the hands of non-residents are subject to 25% withholding taxes plus a surcharge of 5.5% of the tax due, equating to an effective tax rate of 31.65%.)

(NB. +French dividends in the hands of EU residents (excluding France) are subject to 21% withholding tax. French dividends in the hands of non-EU residents are subject to a 30% withholding tax).

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