Description

Bawag currently seems like a timely and great opportunity to me. The SVB and Credit Suisse fuckups as well as CRE problems and economic softness have suddenly brought risks for financials front and centre again. The abrupt desire to derisk exposure has led to a global sell-off in financials over the last month which also dragged down Bawag (-25%) regardless of the fact that the bank is not suffering from any of these issues. 

Bawag continues to have improving financials, is conservatively as well as extremely well managed, has no funding or duration issues and is also very cheap - selling for less than 6x this year's earnings (also below book). Most impressively Bawag operates with a best-in-class cost-income ratio of ~36% (target for this year is <34%) down from ~70% a decade ago when current management took over. The outstanding operational efficiency is their secret sauce to achieve their leading profitability with a target of >20% on tangible equity of the next few years. Their NIM is pretty standard a little over 2%. 

As an Austrian bank, Bawag should fly completely under the radar here but given the past ownership history of Cerberus and Golden Tree and their unusual management team for an Austrian bank, it has already been eloquently written up by Ad17 in November 2019 once; two years after Bawags IPO. Everyone interested should read Ad17’s write-up for an overview of the background story. The thesis has actually played out well and was recently timely closed out before the sell-off. 

Bawag’s management team has done impressive work over the last decade, and while Cerberus and GoldenTree’s time is now up and both are gone, the management team has increasingly more skin in the game (~4%). The CEO alone has bought another ~€3,2m in the open market since the SVB blowup, worth more than a year’s after-tax salary. He now earns more  from dividends than in annual compensation after tax and his undervalued shares are worth ~€50m (10x his cash comp before tax). Other management members have also used the recent sell-off to buy more shares. They are regular buyers and none of these guys has sold any of their comp-allocated or outright purchased shares in any meaningful way. Since coming public 5 years ago they have all been accumulating shares.   

The main value of my write-up here is bringing this idea to the deal-hungry club's attention at a time when the interest in financials is way above average and Bawag is trading way below a reasonable valuation - vs their own history and in general terms. I am no banking expert so this write-up will be brief and it is also an important disclaimer. I only have a superficial understanding of banking regulations in Europe and there is no value if I am talking about it here in length. I might miss something important here, but from reading through their materials of the last few years and comparing Bawag to their peers I don’t think that's the case. As an Austrian, I also might be home-baised for basically the first time ever... :P 

My thesis for Bawag is simple. 

1) The management team is great with a lot of skin in the game. They have consistently hit or exceeded their targets and I think they don’t want to change that. They are young (almost everyone is below 50) but they have already a proven track with many smart decisions over the last decade at Bawag. They haven’t been dealt the best hand, this is not JPM or something, but they have turned this into one of the most profitable banks in Europe. To me, they seem conservative in their lending but aggressive and unconventional where it makes sense (cost out, geographic mix, M&A). They seem to be very good stewards of capital and they are also no-bullshit straight shooters which I always like. The reporting is also easy to understand. Some people might say they are overpaid, but I don’t think so. They have created an enormous amount of value and it's deserved. I also don’t have an issue with it given that they are blowing back their earnings into stock. 

2) At less than 6x this year’s earnings Bawag is simply too cheap - maybe even if they were an average bank, but they are way above average. Bawag has returned €2b in capital over the last five years vs. a current market cap of €3,5b and the reasonable base case is that the next five years will be more rewarding than the last 5 years have been. They are starting from a much more profitable base and we might also have the benefit of a more normal rate environment in Europe. There is a reasonable path here to get to 3x earnings in 3 years' time adj. for capital returns from the current valuation. That gets me excited.   

3) Management has proven to be great at allocating capital besides core lending operations and there should be more of those opportunities in the future. So there is a decent chance that we will see decent returns from the money they keep if history is a guide. Their playbook is basically acquiring underperforming targets and applying their operational improvement playbook to those targets. They have a sound platform to do that and not that many people in their core markets are going after those opportunities.  

From the IR Day in 2021: “The 9 closed acquisitions were P&L accretive on Day 1. We were able to transform the businesses from a Day 1 average RoTCE of ~3% to over 15%, which took on average 2-3 years to execute.” 

Their M&A approach is quite opportunistic and they act fast when the right opportunity comes along. Their past acquisitions also were in no way driven by achieving growth, it is all about return on investment. A good example is last year's purchase of forced the wind-down of Sberbank.

“We acquired a consumer loan portfolio as part of the Sberbank Europe wind-down process, which added approximately EUR 500 million of assets during the second quarter. This was an idiosyncratic opportunity requiring a deep dive underwriting of a German consumer loan portfolio. We underwrote the portfolio to a target return on equity greater than 30%, assuming highly stressed losses and landed at a net profit margin of approximately 4%. We feel very good about the portfolio purchase as this will be highly accretive to the business over the coming years.”

4) They have a resilient conservative balance sheet. Bawag was among the best-performing European banks in the 2021 ECB stress test. They have a strong capital position (CET1 ratio of 13,5% post the Q1 dividend) and healthy gross capital generation ability at >250 bps p.a. Their liquidity coverage ratio is above 200%. Their NPL ratio is below 1%. They have stayed away from reaching for yield in Eastern Europe, Ukraine or Russia. They have no large corporate book. Their securities portfolio is actually underinvested and they could do more there, they have waited for better spreads for years. Over the last several quarters they have built an additional reserve on top of their normal cost of risk, now worth a normal year of the average cost of risk. There are also no noteworthy legal risks and they don’t operate a lumpy and more risky investment banking business. The funding side looks decent to me and they have also not exposed themselves to undo duration risk. Their core region of Germany and Austria has a large overhang (€1 trillion) of savers vs. borrowers, so deposit flight and fight here is not a large concern. Again, I am no banking expert but everything is looking decent to me.  

There is a lot of detail in the IR Day, on for example how they have achieved their operational improvements etc. and in their ongoing reporting that should quickly answer most questions better than I can lay them out here. There is also good background info in Ad17 writeup and there are 2 helpful tegus calls for whoever has access. I am no fan of copy-pasting stuff here, there are enough charts already. The main thesis points are laid out. I think this idea is timely and it should do very well. It is also not that controversial. Insiders are buying https://www.bawaggroup.com/en/investor-relations/share-information/shareholder-structure (list at the end) and basically, every analyst covering BAWAG has a buy rating with targets in the €70s on the stock vs. a current price of €44. https://www.bawaggroup.com/en/investor-relations/share-information/analysts

Catalyst

No specific catalyst, but the cheapness shouldn't persist forever

One is also well compensated to wait with a close to 10% dividend yield plus some buybacks