Sberbank is punished due to its location despite a forward-looking, shareholder-friendly management, strong financial performance, growth prospects, and cheap valuation.
Key Points
- Leading financial institution in Russia and one of the largest in the world trading at a discount to model and at a sub 10x P/E.
- Shareholder friendly management with high dividend payout, frequent publications in English and strong willingness to stay in front of the curve via investments in technology.
- Historical strong double digit growth which is expected to continue in the medium-term.
- Market capacity to expand as the country is underbanked. Russian fundamentals appear solid.
- Multiple ways to win. “Heads I win; Tails I don’t lose much” (Mohnish Pabrai).
Company Description
Sberbank is the largest bank in Russia and Eastern Europe, top 30 in the world ranked by market cap (in USD), and top 50 in the world in both deposits and loans. 50% + 1 share is owned by the Central Bank of Russia, 45.5% by foreign institutions and the rest by domestic investors.
The bank dominates the local market and uses its firepower to remain in the lead by investing in technology but also in non-banking services. If the words Russia and Sberbank were absent from the firm’s material then one would think this was a western company. That is the impression given by the bank’s values, analyst day and general online presence. The Sberbank banking app has been highly successful with a 4.6 and 4.8 rating in the App Store and Google Play respectively. It ranks top 10 not only in Russia but in other countries as well. 71% of active customers are digital users. Sberbank is using the expertise they have gained to expand into a number of services such as fintech, e-commerce (JV with Yandex), health care, B2B services cybersecurity, e-real estate, cloud, health care services, SIM cards, food reservations, and even education (Sberbank University, School 21). Essentially an entire ecosystem.
(Source: Sberbank)
These could be a source of significant future upside (in a similar manner that Amazon initially developed AWS for internal use before making it available to outside clients). There is significant value to all the data collection which can be used to cross-sell additional services. It wouldn’t be farfetched to say that in 10 years Sberbank could be classified as a tech company rather than a traditional bank. This may look like one big mess but Sberbank appears to have everything under control. In response to a question during their analyst day, Ekaterina Latypova mentioned how they use personalization to offer the appropriate services to each business (for example, they wouldn’t offer education on entrepreneurship to a large organization). The process of contacting clients has also been systemized so as not to be a pain to customers. This is done via technology, client profiling, the use of online dashboards within teams that set targets and goals.
Management & Shareholder Friendliness
Herman Gref has been the CEO of Sberbank from 2007. Born in Kazakhstan, a son of an ethnic German family, he studied law at Omsk State University and St. Petersburg University. He has known Putin from his days at the St. Petersburg City administration and it is my understanding he has his ear. He was appointed economy minister in 2000. During his time, he advocated for reforms which resulted in a 13% personal tax rate, lobbying to join the WTO and the start of state privatizations. When he moved to Sberbank he pledged to “teach an elephant to dance” and has since reformed the bank, invested in technology and has put forth targets which he has delivered on. During the April 2013 Investor Day, Gref promised to bring the cost to income ratio down to 40-45% during 2014-2018. In 2012 it was 51% but by 2018 it had dropped to 37% thus exceeding his own target. The key goals for 2020 include RUB 1 trillion at an ROE of around 20%. Furthermore, the bank plans on gradually increasing the dividend payout ratio to 50%. The company publishes a presentation update almost every month in English while their online annual report is impressive and has received an award. The company even has an Investor Relations app. Gref advocates for less government involvement, and a lower stake while continuously pushing the bank forward. He appears to have added value as he has modernized the bank while being shareholder friendly. His friendship with Putin is a net positive in my opinion.
(Source: Apple App Store)
Growth Story
Despite being the largest bank in Russia, Sberbank has continued to grow at significantly high rates. Below are the 3, 5, 7 and 12-year annual growth rates in operating income before provisions, EPS adjusted, total deposits, total loans, and total equity.
Account ownership is still low in Russia compared to developed economies and thus there is still significant room to grow. Below is a collection of charts from a 2018 World Bank report. A significant amount of payments received from the government and the private sector are still in cash or other methods. Over time we can expect this gap to close. The growth in smartphones and mobile banking is likely to play a role and thus Sberbank’s investments in technology can be expected to help it participate. A cashless Russia is actually among the bank’s strategic initiatives. There is a RUB 11 trillion cash market around transportation, education, government services and retail that Sberbank wants to tap into. They actually own and manage the POS terminals (vs the western approach of asking the merchants to pay for it). In retail, they use QR codes to lower card acceptance costs and provide the opportunity to pay by phone without NFC.
(Source: World Bank, Global Findex Database)
Some additional statistics:
- 2017 Household debt to GDP was 16% for Russia compared to 25% for Brazil, 49% for China, 57% for Greece, 86% for the U.K. and 78% for the U.S. (Source: IMF).
- 2017 Nonfinancial corporate debt to GDP was 52% for Russia compared to 44% for Brazil, 157% for China, 62% for Greece, 83% for the U.K. and 73% for the U.S. (Source: IMF).
- 2016 Bank Deposits to GDP was 50% for Russia compared to 59% for Brazil, 72% for Greece, and 81% for the U.S. (Source: FRED).
So the overall message here is that Sberbank has grown historically and the capacity exists for it to continue to grow.
Macro & Risks
The main risks for Sberbank are largely out of their own hands as they are external in nature. Firstly, the Russian economy depends on the oil and gas sector so a decline in prices could affect the wider economy and Sberbank. When oil prices dropped in 2014-16, the economy fell into a recession with GDP dropping -2.8% in 2015 yet Sberbank’s ROE still remained in the double digits (+10.2%). Its worst ROE in the last 20 years was in 2009 following the global financial crisis when Russian GDP dropped -7.8%. Even then, ROE was still positive at +3.1%.
Russian government debt to GDP is 13.5% compared to Brazil’s 77.2%, China’s 47.6%, and the United States’ 105.4% (source: tradingeconomics.com). Russia has had a current account surplus for over 20 years while international reserves are almost $500 billion (vs ~$1600 billion of GDP). Over the last year, the core inflation rate has risen from a 2.2% low to around 5% but still much better than the historical rate which was in the double digits.
Many consider economic sanctions to be the biggest risk. I have no particular insights to provide, however, barring any additional military actions by Russia, it is my opinion that this risk is lower than perceived. The annexation of Crimea was 5 years ago and as time passes the event is likely to be forgotten. The Parliamentary Assembly of the Council of Europe last week decided to allow the Russian delegation to return with full voting rights with 118 votes in favor, 62 against and 10 abstentions. France and Germany were in favor while the U.K. was against. While the probability is not negligible, Russia is currently too large and intertwined into the global system for extreme measures. Of note is what Gref said in a 2015 interview “And once the sanctions are over, we will expand heavily in Europe once again. We have the advantage of having modern banking technology and superior products in the area of digital banking.”
Tier 1 capital has fluctuated in the low double digits while NPLs have been in decline at under 4%. The reserve for loan losses to non-performing loans is 189%.
Valuation
Bank stocks are more efficiently priced than other equities. This is possibly due to homogeneity between them and tighter common regulations that they must follow. For example, see the below chart showing the top U.S. banks based on return on tangible book versus price to tangible book. While P/B and ROE are most common, P/TB and RoTE regressions are a better fit with higher r-squared. As shown, the r-squared is 99%. Therefore, an investor can only earn abnormal returns if they can better estimate profits (easier said than done) or make a purchase when earnings are temporarily suppressed (as when in a recession – which doesn’t occur frequently).
In my own research of global banking stocks I found that valuation can mostly be explained by the following factors: 1) Location: country and economic development (i.e. developed, emerging, frontier), 2) NPLs (the higher – the larger dislocation vs predicted valuations), 3) Size based on loans or deposits (the large the deposits the more behaved the model) and of course 4) RoTE. To prove my point see the below 2 charts. On the left is a regression showing North American Banks (Canada and US Diversified, Regional, Investment banks, and Custody), while on the right is the same sample including only banks with deposits above $300 billion.
Below is the regression with banks from around the world (with special cases excluded – eg. Turkey) and the same model that includes only banks with $300+ billion in deposits. Based on the below model, Sberbank should trade at around 2.4x tangible equity (or around 100% higher than current market prices). A Latin America model that includes Argentina, Brazil, Chile, Colombia, and Mexico does not result in a lower valuation. Obviously, there is a serious Russian discount at play and it is unknown when this will change. Narrowing of this discount is a free kicker.
Taking a historical multiple approach, price to book reached a high of 1.8x as recently as February 2018 which represents ~40% upside from current valuations while the P/E ratio reached a high of almost 12x in November 2015 (representing ~87% potential upside). A RUB 1 trillion profit in 2020 implies an EPS of ~RUB 47. At 8x earnings, the stock is worth RUB 376 (or ~$24 for the London listed stock). Based on the above, Sberbank expected upside is between 50-100% over the next 2 years.
(Source: Bloomberg)
Catalysts / Conclusion
There are numerous ways to win in Sberbank. Firstly, high single to low double-digit growth is expected to continue and will reward the patient as the company continues to compound. A higher dividend payout will increase the yield (currently ~6.5%) thus rewarding investors to wait and attract income-seeking investors. Tensions between the U.S. and Russia will relax for any number of reasons (eg. a new common enemy, foreign investment, further reforms bring Russia close to the west). Finally, there is a free option in all the non-banking services which the market places no value on and could significantly boost returns via multiple re-rating, spin-offs, or just additional product lines. Even if the valuation does not change, EPS and book value will rise hence reducing the likelihood of a loss. Even in the event of a recession, a longer-term holder is likely to be fine as the bank has shown an ability to survive and has the same experienced management in place.
