Societe Generale: Call Option On Improving Profitability (SCGLF)

Introduction

I previously covered Societe Generale’s (OTCPK:SCGLF) Investor Day back in September 2023 where I argued that despite a lower profitability target compared to peers such as BNP Paribas (OTCQX:BNPQF) and Credit Agricole (OTCPK:CRARF), Societe Generale still made sense as an investment due to its lower valuation. Since then both SocGen and BNP have moved lower, with only Credit Agricole managing to generate gains:

It is true that the near-term results of SocGen have given little rationale for re-rating relative to peers, with a profitability warning weighing on BNP Paribas recently. Nevertheless, my overall thesis remains unchanged. With SocGen trading at only 0.36 price-to-tangible book compared to 0.65-0.8 of other French peers, the upside potential is very well intact.

In today’s article, I will provide an update on SocGen’s Q4 results, its 2024 outlook, and how key subsidiary valuations compare to SocGen (sum of the parts approach).

Operational overview

Societe Generale’s Q4 2023 results are available here. The bank reports operations in three key businesses, namely French Retail, Private Banking and Insurance at 32.8% of Q4 2023 net banking income, Global Banking and Investor Solutions at 36.7%, and International Retail, Mobility and Leasing Services at 33.8% of Q4 2023 net banking income. Let’s see how each of the businesses performed.

French Retail, Private Banking and Insurance was the weakest performer in both Q4 and 2023. Net banking income fell 14.3% Y/Y in Q4 (2023: -12.9%), impacted by short-term interest rate hedges. As a result, the return on normative equity (RONE) was only 2.4% in Q4 (2023: 3.9%).

Global Banking and Investor Solutions recorded an 11.1% Y/Y drop in Q4 net banking income (2023: -4.6%) against a record prior-year quarter. Nevertheless, the low cost of risk helped keep RONE at 12.3% in Q4 (2023: 14.8%).

International Retail, Mobility and Leasing Services was arguably the best-performing business in Q4 but still delivered a 4.5% drop in Q4 net banking income (2023: +4.5%), driven by a normalization of results at vehicle lessor Ayvens (formerly known as ALD). RONE was 10.9% in Q4 (2023: 16.5%).

On a consolidated basis, net banking income fell 9.9% Y/Y in Q4 (2023: -7.6%), cost of risk was 24 basis points in Q4 (2023: 17 basis points), tangible book value per share was 62.7 EUR/share at the end of 2023 (2022: 63 EUR/share), Return on Tangible Equity (RoTE) was only 1.7% in Q4 (2023: 4.2%), impacted by a total of 730 million EUR of transformation charges in 2023. The cost/income ratio was 78.3% in Q4 (2023: 73.8%).

Capital Position

SocGen ended 2023 with a CET1 ratio of 13.1%, down 0.2% Q/Q on higher risk-weighted assets, but still some 290 basis points above its current 10.22% requirement. As a reminder, SocGen previously communicated a 0.85% impact on CET1 capital from the final implementation of Basel III rules expected in January 2025. Liquidity remains exceptionally high, with a liquidity coverage ratio of 160%, and a loan-to-deposit ratio of 80%.

Despite, arguably, a weak performance in 2023, the bank is set to propose a 0.90 EUR/share dividend and a 0.35 EUR/share (or 280 million EUR) share buyback.

2024 Outlook

For 2024, SocGen targets higher revenues, which in combination with lower costs and a marginal increase in the cost of risk should result in higher profitability:

As you can see from the picture above, revenue growth is seen at or above +5% vs. 2023, the cost/income ratio is targeted at less than 71%, and the cost of risk is set to rise to between 25 and 30 basis points in 2024, resulting in an RoTE of more than 6% in 2024 with a CET1 ratio of around 13% at year-end 2024.

2024 will bring 190 million EUR in additional restructuring costs at Ayvens, while the bulk of the LeasePlan acquisition synergies are expected for 2025 and 2026. As a result, while improving in 2024, profitability will take some time to reach the 9-10% 2026 RoTE target.

Sum of the parts update

SocGen currently holds majority stakes in some key exchange-listed subsidiaries, namely:

Click to enlarge

Source: Author calculations on company disclosures

While Ayvens, still trading under the ALD ticker, has fallen significantly over the past year, all three key subsidiaries trade well in excess of SocGen’s 0.36 price/tangible book ratio, implying significant upward potential once profitability in French Retail, Private Banking and Insurance stabilizes. Alternatively, SocGen may eventually sell some of these subsidiaries (the bank is already selling assets in Africa, with Chad and Congo exits already closed):

Conclusion

Hedging and high deposit rates in France have resulted in SocGen missing out on a goldilocks environment for European banks. Nevertheless, I reckon that while uninspiring, the bank’s over 6% RoTE ambition is easily achievable, dependent largely on interest rate hedges expiring. The true value in the stock will only be achieved if RoTE continues improving in 2025 and 2026, eventually reaching the 9-10% target. Alternatively, exits of more markets in Africa or Europe can release significant amounts of capital, akin to what happened when BNP Paribas sold its Bank of the West subsidiary in North America. However, as was seen with BNP Paribas, the bank experienced some profitability issues after disposing off trophy assets. All in all, while financial engineering in the form of subsidiary sales and buybacks can help SocGen, structural improvement in the profitability of the French Retail, Private Banking and Insurance division is needed to put the bank on sound footing.

One can view SocGen as a call option on improving profitability, with the stock currently pricing continued lackluster performance. As communicated in the Q4 results press release, management plans to “provide precise, regular and transparent reports on our progress toward our announced 2026 objectives.”, which will be key for the SocGen call option moving consistently in the money.

Thank you for reading.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.