UniCredit Q4 Earnings: 2024 Guidance Looks Bullish After Outstanding Results (UNCFF)

Italian bank UniCredit (OTCPK:UNCRY)(OTCPK:UNCFF) has continued on its upward march since I opened on the name with a Buy rating in October, with the ADSs delivering a circa 27% total return in that time amid significant outperformance against wider European financials.

Much of that outperformance came immediately following the release of Q4 2023 results earlier this week, with the shares ending the day (Monday 5th Feb) around 9% higher after smashing sell-side consensus estimates across the board. Looking forward, I said in my opening piece that earnings had likely peaked here in Q2 and Q3 of last year. While that looks likely to be the case based on Q4 numbers, 2024 guidance of flat net income is nonetheless bullish given the drivers required to make this work.

My initial Buy case at UniCredit was by-and-large a generic one that applies to a number of European bank stocks: namely that the discount to tangible book value attached by the market implies a return to the pre-2022 zero/negative interest rate environment in the Eurozone. That leaves a lot of upside given the step-up in profitability that would occur even with modestly positive rates.

The above remains the case despite the strong shareholder returns generated since initial coverage. With UniCredit also continuing to offer one of the strongest capital returns stories in the space, these shares remain attractive, and I leave my Buy rating in place.

A Strong Q4 Beat

After disappointing Q4 reports at recently-covered ING (NYSE:ING) and BNP Paribas (OTCPK:BNPQY)(OTCPK:BNPQF), results at UniCredit landed at the opposite end of the spectrum, with the bank delivering a very strong beat right across the board.

With that, net interest income (“NII”) came in at €3.61 billion in Q4, which was roughly flat QoQ but ahead of consensus by around 4%. Beats on non-interest income (€2.37 billion) and operating expenses (€2.49 billion) led to pre-provision operating income of €3.49 billion, which came in well ahead of the average sell-side estimate of €3.05 billion.

I mentioned last time out how the higher interest rate environment in the Eurozone had finally allowed UniCredit to realize the benefits of its deposit franchise, with this being one of the main drivers of a large uptick in profitability here. This is especially true in the bank’s core Italian market, which accounts for around 45% of group operating profit.

Total sight deposits amounted to just under €349 billion in Q4, which was down around 9% year-on-year but up circa 1.6% QoQ. In a period in which banks have been grappling with higher funding costs, UniCredit reported a group-wide average pass-through rate of just 28% in Q4, which was only around 3ppt higher than both the Q3 and 2023 average. With its average yield on loans up 21bps sequentially to 4.54%, stickiness in the deposit base is what is keeping net interest income elevated, with sequentially flat NII a very good result given the broader macro environment for banks.

Credit costs have been the other driver of UniCredit’s uptick in profitability. Though materially higher than in the first three quarters of 2023, loan loss provisions were €300 million in Q4, around €355 million lower than consensus and mapping to a cost of risk (“CoR”) of 28 basis points.

Credit quality remains resilient. Gross non-performing exposures (“NPEs”) were steady at around 2.7% of total loans last quarter, with an uptick in Central Europe offset by declines in Eastern Europe and Italy. At 17.2%, Stage 2 loans fell 40bps as a portion of total loans.

All told, the above helped drive a huge bottom-line beat, with Q4 net income of €1.9 billion mapping to a circa 14% return on tangible equity (as management calculates it) and roughly double the figure analysts had penciled in.

2024 Guidance Looks Bullish

While Q4 results far exceeded expectations, forward guidance was arguably just as bullish if not more so, with management targeting flat net income of €8.6 billion for 2024. Assumptions baked into that guidance include stable average interest rates versus 2023, deposit beta inching up to 30%, and CoR remaining below 20bps.

Management’s rate assumptions roughly align with the market’s current view based on the forward curve. Suffice to say there is upside/downside here depending on what the ECB actually does throughout the year. I would also be inclined to accept management’s pass-through assumptions given how strong the cycle-to-date deposit beta performance has been.

CoR guidance looks the most ambitious element to me, with sub-20bps still below the low-end of management’s through-the-cycle target of 20-25bps. Now, this longer-term goal has always struck me as fairly punchy given UniCredit’s loan book skews more to businesses. Just by way of comparison, Italian peer Intesa Sanpaolo’s (OTCPK:ISNPY)(OTCPK:IITSF) loan book sports a circa 5ppt higher share of residential mortgages (27% of loans versus 22% at UniCredit), with the bank targeting a higher through-the-cycle CoR of 30-40bps. UniCredit’s stock of Stage 2 loans (17.2% of loans as per above) is also relatively high versus peers, though this could also reflect management prudence.

Before Q4, consensus was pointing to around 30bps in 2024 CoR. While it is true that analysts have been playing catch up here, I would say risk probably skews a bit more to the downside in terms of achieving 2024 guidance. On the flip side, the bank has around €1.8 billion in overlays on Stage 1 and 2 loans that it could deploy should the credit cycle come in softer than expected over the next couple of years, and this could provide a source of upside to earnings.

Margin Of Safety Still Present

UniCredit shares trade for €29 each in Milan trading at time of writing, with the ‘UNCRY’ ADSs at $15.44. This equates to a valuation of approximately 0.85x year-end 2023 tangible book value per share (“TBVPS”) and a P/E of ~6x 2023 EPS.

Despite returning around 27% since last coverage just a few months ago, these shares are still not expensive. Net income guidance maps to a return on tangible equity of around 16%, easily justifying the current valuation. Yes, 2024 net income is still not going to be representative of UniCredit’s mid-cycle earnings power. Interest rates are set to fall, while 2024 CoR remains below the level of provisioning the bank is likely to average across the cycle. 2025 will be a very different year in terms of net income. This and more are already baked into the stock’s TBVPS multiple.

With Eurozone rates at around 2% and CoR at 35bps, I estimate UniCredit can generate a circa 12% ROTE. That should be good for a fair value of around 1.1x TBVPS, or around $19.50 per ADS, implying around 25% upside from the prevailing price.

Regardless of whether the shares reach this multiple in the near term, capital returns potential remains amongst the most compelling in the space. UniCredit is generating capital in excess of net income, while its current capital ratio further supports a high payout ratio, with the banking ending 2023 with a circa 15.9% CET1.

Capital returns are guided at €10 billion for 2024, implying a best-in-class shareholder yield (dividend yield plus buyback yield) of 19% based on the bank’s current market-cap. This looks especially attractive given my calculated discount to fair value above. While capital returns are obviously dependent on net income guidance, returns potential remains compelling even if the macro assumptions underpinning this turn out to be too optimistic. With the stock’s current discount to TBVPS further providing a margin of safety, I remain comfortable with my initial Buy rating.

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