Raiffeisen Q1: Still Too Cheap Even Excluding Russia (OTCMKTS:RAIFF)

Austrian bank Raiffeisen (OTCPK:RAIFF)(OTCPK:RAIFY) has been a fairly weak performer since my last update at the end of 2023, with a -12% total return representing over 20ppt of underperformance versus broader European financials (EUFN) in that time. The stock has, however, fared better since I opened on it around a year ago, outperforming peers with a roughly 30% total return in this period.

Raiffeisen’s income statement continues to be somewhat noisy, with significant Russian exposure, Polish FX mortgage provisions, a stagnating top line and resilient asset quality all pulling in various directions.

While this paints a somewhat complex picture right now, Raiffeisen’s valuation continues to look modest, with the shares trading for just 0.45x book value per share even after stripping out the Russia business entirely. With the bank’s return on equity in the 9-10% range on the same basis, these shares continue to look cheap relative to core earnings power. As such, I keep my ‘Buy’ rating in place.

Investment Case Recap

Raiffeisen is one of the largest banks in Central Europe, with operations also spanning across a number of Eastern and Southeastern European markets. Total assets stood at circa €205 billion at the end of Q1.

One of the distinguishing features of Raiffeisen is its material exposure to Russia and Belarus. Combined, these contributed around half of the group’s consolidated profit last quarter.

Given the state of the current relationship between Russia and the West, Raiffeisen is essentially unable to repatriate earnings from its Russian business. Furthermore, there remains a significant possibility that it would be unable to repatriate proceeds from any sale of the business. Despite this, Raiffeisen’s valuation has been too cheap relative to its earnings power, with the stock trading below 0.5x book value at previous coverage even after assuming a full write-off of the Russian business.

Many Moving Parts To Consider

Raiffeisen released first quarter results last week, with consolidated profit of €664 million mapping to a ROE of 15%. The bank’s businesses in Russia and Belarus contributed around half of this, and it remains prudent to analyze the bank excluding this. With that, earnings at the ‘core’ bank came in at around €333 million, beating consensus by around 8% but mapping to a lower ROE of 10%. Figures presented from here will likewise be on an ex-Russia/Belarus basis.

Russian exposure aside, Raiffeisen’s income statement contains a number of other moving parts currently. For one, the tailwind to net interest income (“NII”) from higher interest rates has now largely played out, with central banks in key markets like the Czech Republic (~13% of revenue) and Hungary (~11%) now firmly on the path of rate cuts. Czech net interest margin (“NIM”) of 2.06% was down around 26bps sequentially last quarter, while Hungarian NIM contracted by circa 35bps to 4.50% on the same basis. At the same time, loan growth in these markets remains challenging as higher rates and inflation have sapped demand for credit. Loans to customers fell ~1.4% quarter-on-quarter in the Czech Republic and 4.5% in Hungary.

With the above in mind, group-wide NII and NIM have likely seen their peaks in this interest rate cycle. In Q1, group NII fell 2.7% sequentially to €1.09 billion, while NIM contracted by around 7bps sequentially to 2.46%. Management is guiding for around €4 billion in NII this year, while total loans to customers is seen growing 3-4%. This implies continued NIM contraction throughout the year.

While this represents a headwind going forward, I would make two points regarding this. Firstly, NIM remains well above levels seen before the hiking cycle began. Secondly, and as per management guidance, rate cuts should spur a recovery in demand for credit, helping to moderate downside to NII as volume growth somewhat offsets lower margins.

Below the revenue line is where things get slightly more complex. As I mentioned in previous coverage, Raiffeisen has been building provisions against legal action regarding legacy Swiss franc mortgages in Poland. This was a ~€109 million headwind to income in Q1, while management expects that figure to increase to around €340 million for 2024 as a whole. As provisioning in this portfolio is now approaching 100%, I expect this headwind to fade significantly from 2025.

On the flip side, general provisioning for bad debt was again very low in Q1, with the €3 million charge beating consensus by around €90 million and equating to a cost of risk (“CoR”) of just 5bps of customer loans. This is well below the 50bps that management expects for the full year, and roughly cancelled out the headwind from Polish legal provisions last quarter.

Looking ahead, management did specifically call out the idea that they may be sandbagging a little on 2024 CoR guidance on the Q1 earnings call. Given that the Q1 expense was just 5bps, this clearly implies a significant uptick across the remaining three quarters, while the €340 million estimated provisioning charge related to Poland remains in place. As such, I expect quarterly consolidated profit to dip a little over the rest of 2024, before rebounding next year as the Polish headwind fades and CoR normalizes at around 50bps of average customer loans.

Shares Still Good Value

With the above in mind, Raiffeisen still looks reasonably valued at its current level. The primary-listed shares in Vienna trade for €17.62 apiece as I type ($4.86 per ADS), equating to just 0.45x book value per share (“BVPS”) as of Q1. I will reiterate that this figure excludes equity from the Russian and Belarusian businesses.

This multiple looks too cheap relative to the core bank’s earnings power. Management guidance has ROE at “around 10%” this year, while I have it a shade lower at closer to 9%. Raiffeisen should be able to defend this level of earnings next year and in 2026, as headwinds in the form of NIM contraction and normalizing CoR are offset by loan growth and the roll-off of Polish mortgage provisioning. At a ~9% ROE, Raiffeisen would still offer investors a roughly 20% internal rate of return at the stock’s current multiple of book value.

To estimate medium-term returns potential requires three inputs: growth in BVPS, the terminal BVPS multiple applied by the market and, lastly, cumulative per-share dividend payments.

Starting with the last component, management has technically suspended medium-term payout targets while the situation with its Russia business remains unresolved. That said, the 2023 payout of €1.25 per share (~€410 million in aggregate cash terms) mapped to a payout ratio of just over 40%. Applying this payout ratio to the three-year 2024-2026 period, I estimate cumulative dividend payments of around €1.54 billion, or €4.70 per share based on 328.9 million shares outstanding (~$1.25 per ADS at current FX).

This level of retained earnings should drive around 6% annualized growth in BVPS relative to year-end 2023, resulting in a per-share figure of roughly €44 (~$11.85 per ADS) in three years. I do apply a slightly higher cost of equity (11%) to Raiffeisen given the nature of its geographic exposure. As this is above my ~9-10% ROE expectations, Raiffeisen would continue to trade at a discount to book value, albeit with this narrowing to around 0.8x versus 0.45x currently. This results in a terminal share price of €35.20 (~$9.50 per ADS), increasing to €39.90 per share (~$10.75 per ADS) inclusive of dividends. With this implying a around 30% annualized pre-tax total return relative to the prevailing quote, I keep my ‘Buy’ rating on Raiffeisen in place.

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