Description

Link to the PDF of this write-up: https://www.dropbox.com/s/0nz40hzlq7spkaz/SUPV.pdf?dl=0

Grupo Supervielle S.A. (NYSE: SUPV)

• Grupo Supervielle is well positioned to take advantage of the positive macro and banking trends unfolding in Argentina.

• President Macri’s market friendly policies are expected to be the catalyst that reduces inflation and jumpstarts growth.

• The Argentinian banking system is dramatically under-levered compared to the rest of Latin America (15% loan-to-GDP vs 55% LatAm average). We believe inflation and interest rates will normalize to levels seen throughout the rest of Latin America, resulting in explosive loan growth throughout the Argentinian banking system.

• We believe the consensus underestimates the velocity at which loan growth should permeate in the Argentinean banking system by underestimating the structural advantage of having a large, educated and wealthy middle class population.

• Before SUPV IPOed in May 2016, its growth had been restrained by a lack of capital. The proceeds from the IPO should allow SUPV to grow at an above market rate over the next 2 years, thus allowing SUPV to further gain market share.

• Although SUPV has an expansive footprint of brick and mortar banking branches throughout Argentina, SUPV lacked the capital necessary to originate loans per branch at optimal levels. As SUPV deploys its IPO proceeds, SUPV’s efficiency ratio and ROE should normalize with peers.

• SUPV trades at a discounted valuation compared to its Argentinean banking peers. As ROE expands toward industry averages, we feel this valuation gap should narrow, especially in light of SUPV’s above industry EPS growth.

• We believe SUPV is worth $25 (64% upside from current price) in our base case scenario, $18 (22% upside) in our downside scenario, $34 (127% upside) in our upside scenario.

• SUPV has the potential to be multi-bagger over the next 5 years if our investment thesis of secular growth in Argentina unfolds.

Macro Investment Thesis

Almost every decade for the past 50 years, new governments have promised to restore Argentina to the prosperity it enjoyed over a century ago as one of the richest countries in the world. Time and time again investors have been disappointed. What makes the situation in Argentinian different this time around is twofold. First, while the size of the fiscal deficit President Mauricio Macri inherited is similar to that of his predecessor, the composition of the deficit is different. The previous government had to resort to printing money, which resulted in high levels of inflation. In contrast, Macri’s government is able to finance deficit spending with debt. The positive consequence of Argentina being shut out from capital markets for the past 15 years is that it has emerged under-levered (Figure 1). Argentina’s Debt/GDP stood at 46% at the end of 2015, with only a small part of external debt denominated in foreign currencies. By solving its overhang with creditors of Argentina’s bond default, Argentina has opened itself once again to capital markets and effectively lowered its borrowing costs. By not having to revert to severe austerity measures, which typically lead to social unrest and often times topples political regimes, Macri’s deficit reduction plan appears to be more politically tenable. Macri’s approval ratings are still high, even after cuts to utility subsidies. Secondly, Macri’s government spending is more efficient than his predecessors, who often displayed fiscal laxity. Macri has cut untenable subsidies on public utilities and focused government spending on much needed public infrastructure projects.

Figure 1: Leverage of South American countries based on Debt-to-GDP

The Argentine economy is in the initial stages of a major turnaround, which began after the election of President Macri in late 2015. We believe this will have positive effects within the Argentinian banking system. The main obstacle to loan growth has been high levels of inflation, which limit visibility and reduce the appetite for leverage in borrowers and lenders. However, data coming out of the Central Bank of Argentina (BCRA) has shown sequential improvement in inflation statistics. This will serve as the impetus for consumer demand for loans and for banks to increase their loan portfolios.

We believe that the Argentinian banking system has a long runway for growth. Compared to the rest of Latin America, the Argentinean banking system is dramatically under-levered as measured by the private loan-to-GDP ratio. Argentina’s loan-to-GDP ratio is only one quarter of the average in Latin American countries. As inflation and interest rates decline, banks will be able to capitalize on a market that has a lot of pent up credit demand. Further, as the level of interest rates decline, several common banking products currently not offered in Argentina should gain traction: specifically car loans (if interest rates fall into the teens) and mortgages (if interest rates fall into the single digits).

Consensus opinion is that the loan-to-GDP ratio will increase 1.5-2% per year, resulting in a loan-to-GDP ratio of 23-25% by 2020 from a starting point of 15% in 2015. This consensus appears to be anchored to the fact that the loan-to-GDP ratio was 25% before Argentina’s debt default. However, we feel that the consensus expectations for the velocity of credit expansion underestimate several key variables. Starting point matters: Argentina’s loan-to-GDP ratio (15% in 2015) is 40% below the Latin American average of 55%. Argentina has sufficient pent up credit demand, particularly in the corporate sector, after being shut off from capital for the past 15 years post-debt default. If Argentina is upgraded from Frontier Market to Emerging Market by MCSI, which we believe will happen in 2017, secular credit expansion should accelerate with private capital inflows. Further, Argentina’s population demographics are ripe for credit expansion. Argentina has a large, educated, wealthy middle class; a low income inequality gap; low labor informality; and sufficient banking infrastructure already in place.  The stark difference in population demographics and overall economic situations make the velocity of bancarization witnessed in Peru, Brazil, Mexico and Columbia much different than the velocity of bancarization we expect to occur in Argentina. We feel that the economic and demographic characteristics of Argentina best compare to those of Chile, which not coincidently is the most bancarized economy in South America in terms of its domestic private credit-to-GDP ratio. Chile’s private credit-to-GDP ratio grow from 16% to 53% over the years from 1976 to 1981 and is 111% as of the end of 2015 (Figure 2). While we feel that this growth trajectory serves as the upper bound of our expectations, our base case expectation is that Argentina’s loan-to-GDP ratio will grow from 15% in 2015 to 40% by 2021, putting its credit ratio in line with Peru, but still below the Latin American average of 55%. We note that the loan-to-GDP ratio in Paraguay expanded from 15% to 40% in the five years from 2006 to 2011 purely to illustrate that this velocity of credit expansion has occurred in recent history, but in no way infer economic or demographic similarity.

Figure 2: Examples of rapid credit expansion throughout Latin American history

SUPV Investment Thesis

We believe the Argentinian banking sector overall represents a very attractive investment proposition and will rerate to a higher valuation over the next year. SUPV, due to its combination of a clear path to ROE expansion, a faster than average EPS growth, and a valuation discount, is one of the best ways to play the turnaround occurring in Argentina while providing downside protection if our thesis unfolds slower than expected. Even though SUPV has gained market share every year since 2001, SUPV should grow above the industry rate over the next two years as it deploys its IPO proceeds and more than doubles its loan book by mid-2018.

Given that SUPV sees no further need to build new branches, as its geographic footprint already covers much of Argentina, SUPV can focus on expanding the wallet share of existing customers and cross-selling products. As it deploys its IPO capital, SUPV should be able to originate loans across a relatively fixed cost base, resulting in increased operating leverage and an efficiency ratio in line with peers (72% in Q2 16 vs 55% peers). The combination of growth and operating leverage should bring its below average ROE, which we believe to be the reason for SUPV’s valuation discount to other publically traded Argentinian banks, in line with peer averages.  

We believe that SUPV has successfully navigated a deeply recessionary H1 2016 and has in fact shown loan growth at roughly double the pace of the industry through the first two quarters of this year. This gives us comfort that SUPV’s customers, both consumer and corporate, have credit penetration below the system average. Management has noted that they have only been able to write marginal tickets to the corporate, middle market and SMEs segments due to capital constraints. The mix of low credit penetration among existing customers and high expected inflation gives us comfort that SUPV will be able to fully deploy its IPO capital and more than double its loan book by the end of H1 2018, a scenario consistent with our downside case, even if system loan growth is lower than we expect. This makes, SUPVs EPS growth more secure than competitors, which have been well capitalized for several years. We expect the full deployment of IPO capital to add $0.53 EPS. That alone will grow SUPV’s US$ EPADS by 50% from 2016 to 2018. Coupled with the reduction in the efficiency ratio and growth in both service fee income and insurance income, we expect EPADS to grow by 112% from 2016 to 2018 in our downside scenario. However, given our differentiated macro thesis we believe, we believe it is more likely that either our Base Case (149% loan growth, 128% EPADS growth) or Upside Case (210% loan growth, 139% EPADS growth) scenarios will result.

As this thesis unfolds, we believe SUPV will rerate from the 6.4X 2018 P/E multiple that it currently trades at to a 10X P/E multiple, in line with the multiple that Argentinian banks have historic traded at, resulting in a gain of 64% from the current price. Even if SUPV is only able to double its loan book by 2018, as both we fully expect, and SUPV is valued at the 8x 2018 P/E multiple that Argentinian banks currently trade at, SUPV would be worth $18, which is 22% above the current price. Finally, if credit in Argentina expands at the same velocity that occurred in Chile in from 1976 to 1981 and SUPV is valued at a 13x, in line with where other Latin American banks have historically traded during phases of secular credit growth within their countries of origin, then SUPV would be worth $34, a 128% upside.

Figure 3: SUPV expected loan growth and scenario price targets

Macro: From Pariah to Market Darling

Argentina is finally at the inflection point of recovering from the nation’s historic default on $95 B in debt in late 2001 and the ensuing 15 years of stagnation. The election of President Mauricio Macri, a free markets champion, in November 2015 should serve as the necessary catalyst to open and restart the stagnant Argentinian economy. Macri argued that settling with the "holdout" creditors from an earlier debt restructuring and ending Argentina's status as a markets pariah was key to becoming a free market once again. In April 2016, Argentina sold $16.5 B in sovereign debt in an offering that was four times oversubscribed and was the largest ever bond offering by an emerging market. This was Argentina’s first international bond issue since its record 2001 default. The fact that a government with only four months in power has solved an issue which had been pending for more than a decade is a major success. Better access to financing is expected to help Macri carry out his open-market policy reforms without the severe spending cuts that had gotten previous Argentine leader, Cristina Fernandez, kicked out of office. Further, Macri has removed restrictive regulation on the Argentinian Peso, lifted capital and import restrictions, eliminated most of the export taxes, and laid out a plan to lower inflation from the current 30% level.

The Path for Macro Improvement: Regime change in 2015, lower country risk premium in 2016 and strong economic growth in 2017 and onward

The most worrisome aspect of Argentina’s macro situation has been its widening fiscal deficit and reliance on central bank financing. The primary fiscal deficit stood at 5.8% of GDP in 2015, highest in 30 years. From 2012 to 2014, 75% of the deficit was financed by central bank printing. In 2015, it was 56%. The increase in central bank printing was one of the main drivers of inflation and macro imbalances that led to the past 5 years of stagnation. The positive consequence of being shut out from capital market’s for the past 15 years was that it emerged relatively under-levered. As previously noted, Macri is now able to finance the fiscal deficit with debt. This position will allow Macri to gradually reduce the fiscal deficit without resorting principally to central bank printing, which causes inflation, or austerity, which causes social unrest. The Macri government has announced a gradual plan to reduce the primary fiscal deficit to 4.8% in 2016 and eliminate it entirely by 2019, all the while keeping the initial recession and inflation spike in check.

Subsidy cuts to electricity, natural gas, and transport subsidies are expected to total 1.5% of GDP. A further 0.8% of GDP of primary deficit is expected to be reduced through public sector job cuts. To mitigate the recessionary effects of these policies, the government will attempt to stimulate consumer activity in H2 16. An upward adjustment in pensions will be financed through a tax amnesty on repatriated funds held abroad. Further, a reduction of VAT on certain food items for low income households and a proposed universalization of retirement benefits should increase the wealth effect of the consumer, thus leading to increased consumption. Additionally, a government led boost to aggregate demand, principally via public works, should assist in economic recovery in H2 16. These simulative policy measures should increase the fiscal deficit by 1.3% of GDP, netting to a 1% reduction for 2016.

As planned, GDP contracted in H1 16; however, the consumer has mostly digested the inflation spike and hike in utility prices. The wage negotiations that occurred in July 2016 should help the consumer recover some of its lost disposable income. Growth is predicted to resume in H2 16. The rebound led by public investment and consumer spending, should eventually give way to a private investment led rebound. As growth improves, so will the economy’s fiscal situation via higher tax collection. Since inflation expectations are anchored to fiscal deficit reduction, we expect inflation to decline as well.

Inflation, Interest Rates and FX

Evidenced by economic data coming out of the BCRA, inflation is starting to decelerate m/m. The August-16 m/m CPI was -0.8%, the first negative reading in years. While the City of Buenos Aires y/y CPI sits at 43.5% as of August 16, we feel inflation has peaked and will continue to trend down. Although the BCRA targeted a 12-17% inflation target, inflation expectations are 3% above the upper bound of the 2017 inflation target at 20%. Macri expects inflation to reduce to 5% by the end of 2019. Although, we view the BCRA’s targets as overly ambitious, inflation data is moving in the right direction on the back of Macri’s fiscal policy implementations. This has given Argentinian central bankers comfort in cutting the 35-day Lebac rate, which is Argentina’s central bank rate, from a high of 38% in Q2 16 to the current level of 26.75% (Figure 4).

Although we do not take a stance on the FX rate, we note that consensus expectations are for the AR$ to devalue at less than half of its inflation rate, thus appreciating on a real basis (Figure 5). Given FX markets are forward looking, we believe there is room for upside surprise in the AR$ FX rate if Argentina’s growth trajectory proves higher than consensus. If this occurs, this would be an incremental positive to SUPV’s US$ denominated EPS.

Figure 4: The 35 Day Lebac Rate has fallen from its high of 38% to 26.75% and y/y CPI is starting to tick down

Figure 5: Consensus expectations for Inflation, FX and Real GDP growth.

Foreign Investment into Argentina

Argentina has been rated a Frontier Market by MSCI for the past 7 years even though it is South America’s second largest economy behind Brazil. However, Argentina will be included in MSCI’s 2017 annual market review to determine if it is ready to be upgraded to emerging market status. If upgraded, we expect a surge of capital from investors who wouldn’t put their money in a Frontier Market. To put the potential capital inflows into Argentina into context, funds with about $1.7 trillion in assets track MSCI’s Emerging Market index, compared with just $26 billion for the frontier gauge. Argentina’s total market capitalization of $57.3 billion is now one-ninth that of Brazil and below that of smaller economies in the region including Chile, Colombia and Peru, which are classified as emerging markets.

Further, as more capital flows into Argentina, this could induce consolidation within the banking sector. Currently Banco Santander SA is in talks for Citigroup’s Argentinean assets. We note that SUPV could seek tuck in acquisitions to round out its portfolio. It has successfully integrated 5 acquisitions within the past 15 years.

Bancarization of the Argentinean Economy

Argentina is the most under-levered economy in South America as judged by the domestic private credit-to-GDP ratio. While the market consensus is that Argentina offers attractive upside on the back of low penetration, we believe that the market underestimates the velocity at which bancarization will occur and the terminal level at which credit penetration will stabilize. Given that credit penetration is very low for both consumer and commercial loans, Argentinian banks represent an underappreciated multi-year secular growth story.

Further, several one-off policy measures will help with the bancarization process in the near term. A social security package (“Ley de Reparación Histórica”) is a one-off payment to pensioners that have been receiving a lower pension than they should and raises future monthly pensions above inflation. The social security package will significantly increase 2.3 million of Senior Citizen's disposable income in real terms and will likely increase the deposit base within banks. Second, a tax amnesty was announced to help repatriate an estimated US$500 billion of unregistered funds stashed abroad. The repatriated funds will likely flow into the Argentinian financial system and be a net benefit to the banking system.

Argentinean Demographics: Velocity of bancarization should be higher than consensus expectations

Argentina is embarking on the bancarization process with a favorable population demographic; specifically a wealthy population, a better wealth distribution and low labor informality. The population is composed of 56% middle and high income individuals, far superior to the regional average of 38%. Argentina also boasts the second highest GDP per capita in South America, behind Chile. The income inequality gap as measured by the GINI index is much lower in Argentina than peers. All told, a large, educated, wealthy middle-class is a structural advantage in facilitating the bancarization process.

Equally as important, labor informality is much lower than in peer economies. This is important because individuals with formal sector jobs typically have deposit accounts and relationships with banks already in place. Thus, the bancarization process is a function of increasing the wallet share of consumers who already have relationships with banks. This is in diametric opposition to the bancarization process of nations with high labor informality and low income. In these regions, bancarization is more a function of wealth creation, bringing individuals out of poverty and giving them their first bank account. This tends to be a slow and gradual process (i.e. Peru, Mexico and Colombia took a decade for credit to double) (Figure 6).

Figure 6: Domestic credit-to-GDP shows Argentina is the least levered economy in Latin America

Returns of Other Latin American Banks over expansionary credit cycles

Given banks are levered institutions with a relatively fixed operating costs, system credit growth can result in outsized EPS growth, provided banks can access sufficient capital needed to keep pace with industry growth. We highlight Bancolombia and Itau Unibanco as two such institutions that were able to leverage the credit cycle and provide 10-15x share price appreciation over a four year period (Figure 7).

Figure 7: Examples of price appreciation in a secular expansionary credit cycles and Avg. P/E multiples over time period

Company Description

Grupo Supervielle runs a diversified financial platform with units dedicated to:

1. Universal banking (Banco Supervielle): 145 bank branches, 32 senior citizens centers, 11 payment and collections centers and 491 ATMs. Product offerings target individuals; small and medium-sized enterprises ("SMEs"); and medium to large-sized companies in Argentina.

2. Consumer finance (Cordial Compañia Financiera (CCF) & Tarjeta Automática (TA)): CCF has 67 sales points in Walmart stores in larger cities and TA has 20 locations in the Patagonia region. . Product offerings target middle and low individuals.

3. Asset management (Supervielle Asset Management): Asset manager with $520 in AUM

4. Insurance (Supervielle Seguros): Insurance company that has written $32M gross premiums in the past 12 months

5. Microfinance (Cordial Negocios): 9 branches specializing in microfinance

6. Retail (Espacio Cordial): Retail company selling non-financial products and services

While Supervielle’s operations are centered in Buenos Aires, its operational footprint is nationwide. Supervielle commands a strong leadership position in certain niches, such as personal loans, factoring, leasing, active MasterCard accounts, and social security payments (Figure 8). Supervielle successfully targeted some less-serviced markets, such as retirees, leasing, and factoring, thus allowing the group to grow above the system average, and increase its total market share from 0.2% in 2001 to 3.9% in 2Q16, reaching 2.1 million clients.

Figure 8: Strengths in Core Products

Competitive Landscape in the Argentinian Banking system

SUPV is the 11th largest private sector bank within Argentina as of Q2 16. SUPV had 3.9% market share within the Argentinian Financial system, 4.2% excluding public banks (Figure 9). The banking system remains highly fragmented, with many banks having single-digit market share. Argentina has 62 banks, versus 24 in Chile, 25 in Colombia, 45 in Mexico, and 17 in Peru. SUPV has picked up market share every year since 2001. We believe this will only continue as it deploys capital from its IPO. SUPV’s pace of loan expansion should be noticeable in Q3 16; SUPV had proceeds from the IPO for only 27 days in 2Q 16.  Management expects to more than double the size of its loan book over the next two years. Growth will mostly be a function of increasing wallet share of existing clients rather than acquiring new clients through branch expansion or other investments. We believe that this mitigates many of the operational challenges and risks typically associated with growth and gives us confidence that management will be able to follow through with its business expansion plans.

Figure 9: SUPV increased market share every year since 2001. SUPV has a vast nationwide footprint, focused in the locations where GDP per-capita is the largest

Further, we believe that private banks will continue to take market share from public banks. In an inflationary environment, public banks have the cachet of a safer institution in the consumer domain. However, they are not a one-stop shop for all financial needs. We believe that as inflation subsides, private banks will be seen as equally ‘safe’ and multi-platform financial institutions will be able to lure more deposits from the public domain.

Corporate Segment Strategy:

• Larger ticket per client

• Increase transactional services to become primary bank

• Focus on increasing business with strategic clients in growing industries i.e. agribusiness, infrastructure and energy

Retail Strategy:

• Consolidate stable funding base in senior citizens

• Leverage middle-market relationships to grow penetration in quality payroll clients

• Leverage retail client base to increase cross-selling capabilities in affluent and small business segments

• Longer-term offer mortgages & car loans

Consumer Finance Strategy

• Leverage Walmart’s growth strategy to increase penetration of target customers

• Larger capital base provides opportunity to form alliances with medium retail chains

IPO

SUPV IPOed on May 19, 2016, raising US$323M in equity. The IPO was four times oversubscribed and was the first Argentinian bank to IPO since 2007. SUPV’s capital structure consists of 126.7 Class A shares and 237.0 class B shares. Class A and B shares have the same economic interest; however, class A shares have 5 votes and class B shares have 1. During the IPO Supervielle listed 9.5 M Class B shares on the Bolsa de Comercio de Buenos Aires, and 27.4 M ADR’s on the NYSE. Each ADR is equal to 5 Class B shares. Thus, 40.3% of the economic interest and 16.8% of the voting rights were floated in the IPO. Chairman and CEO Julio Supervielle controlled 53.7% of the economic interest and 80.7% of the voting interest (Figure 10). Grupo Supervielle received AR$3.4 B in net proceeds from the IPO, of which AR$2 B was injected into Banco Supervielle, AR$280 M was injected into the consumer finance business (CCF) and AR$1.1 B was retained at the HoldCo (Figure 10).

Figure 10: SUPV’s Equity Ownership and plans for use of IPO proceeds

Moreover, the IPO provides SUPV with capital to grow loan originations rapidly. The pre-IPO tier 1 ratio stood at 7.2% (minimum regulatory tier 1 ratio is 6%), while pro-forma, the post IPO tier 1 ratio stood at 13.5%. SUPV aims to maintain a 10% tier 1 ratio going forward.

If we take our expected 2016 results and impose our 2018 operating assumptions for NIM, efficiency ratio, cost of risk, exchange rate and share count, we expect EPADS to grow form US$ 1.09 to US$1.31. At full deployment of IPO proceeds, we expect loans to grow by AR$ 29 B, resulting in EPADS to increase by US$ 0.53 in 2018 (Figure 11). Growth in fee and insurance income, which we believe should increase with inflation, should also boost EPADS by US$ 0.47 in 2018 given that consensus expectations are for the Argentinian Peso to devalue at roughly half the rate of inflation. Figure 11 presents a bridge from our Downside Case 2018 EPADS to our Upside Case 2018 EPADS.

Figure 11: We expect SUPV’s capital deployment plan to explicitly increase EPADS by $0.53

Efficiency Gains

Due to capital constraints pre-IPO, SUPV originated loans at a lower than industry average loans per branch (Figure 12). Given banking’s high fixed cost structure, this resulted in suboptimal profitability for SUPV. This is evidenced by SUPV’s efficiency ratio (72%) being substantially higher than its peers average (53%). Since SUPV already has a strong nationwide footprint, it will require very little investment in new branches. Thus, as SUPV uses its IPO proceeds to originate more loans over the next two years, we believe that SUPV’s efficiency ratio will fall in line with peer averages and result in materially enhanced profitability.

Figure 12: SUPV will be able to increase its loans per branch, resulting in its efficiency ratio falling to industry averages.

Valuation

Based on consensus estimates SUPV trades at a discount to peer Argentinean banks. SUPV trades at 6.4x 2018 P/E and 1.9x 2018 Book Value compared to the Argentinian banking averages of 7.9x 2018 P/E and 2.2x 2018 Book Value (Figure 13). We feel that this discount is unwarranted given SUPV’s materially higher projected loan growth, which should result in both meaningful higher EPS growth and normalization of ROE in line with industry averages. It is worth noting that Argentinean banks trade at lower P/E than banks in other Latin American countries, particularly on a growth adjusted basis (Figure 14). As inflation subsides and growth in Argentina resumes, we believe that this valuation gap will close.

Figure 13: Consensus estimates of SUPV, Argentinian Banking ADRS and Other Latin American Banking ADRs

Figure 14: Argentinian banks are cheaper than banks in other regions of Latin America. We believe this valuation gap will close as inflation subsides in Argentina.

Modeling Assumptions

• NIM: Should gradually contract from 18.5% in Q2 16 to 14% by 2020 as a result of both a shift to a higher percentage of consumer loans, which carry a lower NIM and a decline in interest rates over time.

• Fee Income: The BCRA authorized banks to increase commissions by 20% starting in Sept 2016. However, post-2016 we conservatively assume fee income increases with inflation rather than loan growth (Note: we expect loan growth to be greater than inflation).

• Insurance Income: We assume insurance income grows with inflation. This is likely conservative since the insurance business is growing off a small base and several insurance products, such as life insurance, will gain traction in lower interest rate environments.

• Tax Rate: Assumed to remain stable at 35%.

• Efficiency Ratio: It should drop from 72.1% in Q2 16 to 55%, the current industry average, by 2018 as operating leverage from loan growth kicks. It should continue to fall post-2018 as the banking industry continues to grow and as SUPV continues to scale its operations.

• Cost of Risk and NPL Ratio should stay relatively stable at historical averages of 3.5% and 3%, respectively. We believe that any near term purchasing power shock the consumer is currently feeling will be mitigated by SUPV’s portfolio composition shifting overtime to a higher percentage of corporate loans, which have a better credit quality than consumer loans. We are likely conservative in these assumptions overtime as these ratios should improve as the economy improves.

• Tier 1 Capital: Although the regulatory minimum is 6%, we assume an equity raise any time Tier 1 ratio dips below 10%.

Scenario Analysis

• Downside Case: Loan-to-GDP ratio reaches pre-default level, 25%, by 2021. We value 2018 EPS at 8x, in line with the average multiple of Argentinean banking ADRs.

• Base Case: Loan-to-GDP ratio reaches a level on par with Peru, 40%, by 2021. We value 2018 EPS at 10x in line with historical P/E averages.

• Upside Case: Loan-to-GDP ratio reaches a level on par with the Latin American average, 55%, by 2021. We value 2018 EPS at 13x, in line with the average forward P/E that ITUB and CIB traded at over their 2003-2007 expansionary credit cycles (Note: by the end of 2007 both CIB and ITUBs forward P/E’s expanded to ~18x)

Results

To double its loan book by 2018, SUPV will need to grow its loan book 17% above our expected industry growth rates in 2016 and 6% above it in 2017, then grow at our downside industry growth rate expectations thereafter (Figure 15). We believe this will reduce the efficiency rate from 68.4% in 2016 to 55% in 2018 and help improve ROE from 22.3% in 2016 to 29% in 2018 (Figure 16). This translates to EPADS growth of 112% from 2016 to 2018. At an 8x P/E multiple, this results in a stock worth $18.00, a 22% upside to the current price of $15 (Figure 17).

Under our base case industry growth forecast, we expect SUPV to grow 22% above the industry rate in 2016 and grow at our base case industry growth rate expectations thereafter (Figure 15). We believe this will help reduce the efficiency rate from 68.4% in 2016 to 55% in 2018, helping improve ROE from 22.4% in 2016 to 29% in 2018 (Figure 16). This translates EPADS growth of 127% from 2016 to 2018. At a 10x P/E multiple, this results in a stock worth $25.00, a 64% upside to the current price of $15 (Figure 17).

Under our upside case industry growth forecast, we expect SUPV to grow 27% above the industry rate in 2016 and grow at our upside industry growth expectations rate thereafter (Figure 15). We believe this will help reduce the efficiency rate from 68.4% in 2016 to 55% in 2018, helping improve ROE from 22.6% in 2016 to 29% in 2018 (Figure 16). This translates EPADS growth of 139% from 2016 to 2018. At a 13x P/E multiple, this results in a stock worth $34.00, a 127% upside to the current price of $15 (Figure 17).

Figure 15: Expectations for industry and SUPV loan growth

Figure 16: Key assumptions and results

Figure 17: P/E estimates and trading multiples based on those estimates

Risks

We believe the main risk is that inflation and interest rate levels fall slower than expectations, limiting the velocity of loan growth within the Argentinian system. We also believe there is operational risk in originating at high growth rates and maintaining underwriting standards without further credit deterioration.

Catalyst

• Grupo Supervielle is well positioned to take advantage of the positive macro and banking trends unfolding in Argentina.

• President Macri’s market friendly policies are expected to be the catalyst that reduces inflation and jumpstarts growth.

• The Argentinian banking system is dramatically under-levered compared to the rest of Latin America (15% loan-to-GDP vs 55% LatAm average). We believe inflation and interest rates will normalize to levels seen throughout the rest of Latin America, resulting in explosive loan growth throughout the Argentinian banking system.

• We believe the consensus underestimates the velocity at which loan growth should permeate in the Argentinean banking system by underestimating the structural advantage of having a large, educated and wealthy middle class population.

• Before SUPV IPOed in May 2016, its growth had been restrained by a lack of capital. The proceeds from the IPO should allow SUPV to grow at an above market rate over the next 2 years, thus allowing SUPV to further gain market share.

• Although SUPV has an expansive footprint of brick and mortar banking branches throughout Argentina, SUPV lacked the capital necessary to originate loans per branch at optimal levels. As SUPV deploys its IPO proceeds, SUPV’s efficiency ratio and ROE should normalize with peers.

• SUPV trades at a discounted valuation compared to its Argentinean banking peers. As ROE expands toward industry averages, we feel this valuation gap should narrow, especially in light of SUPV’s above industry EPS growth.