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Cautiously Optimistic About BBVA

- By Jonathan Poland

Banco Bilbao Vizcaya Argentaria (BBVA) is a Spanish bank founded over 160 years ago in the northern port city of Bilbao. It is the second-largest bank in Spain, but has a global reach with international subsidiaries throughout South America and its two American holdings - Compass and Simple.

After a strong showing in 2016, the bank has to boost its equity to more sustainable levels. To really be on proper footing, the total liabilities should never be more than 10 times the total equity. This is a simple Buffett rule. When you look at Bank of America (BAC) and Wells Fargo (WFC), these companies' liabilities to equity ratios sit at seven times and eight times respectively. Banco Bilbao's liabilities are 15 times its equity.


More importantly, despite its attempt to grow in other countries, it is heavily leveraged to the fortunes of Spain and Mexico, which make up 60% of earnings. Profit in the Spanish banking segment was up 21%, but negative results in real estate resulted in a decrease of 46% in total profits. The U.S. full-year profits decreased 12% to 459 million euros ($484.1 million). In South America, net attributable profits came in 1% higher, while the Mexican subsidiary increased gross income 11% year over year to 2 billion euros. Meanwhile in Turkey, the bank had fantastic results, profits grew 41% to 599 million euros thanks to strong lending volume.

From a pure numbers standpoint, the stock looks cheap. In the last decade, BBVA has earned over 37 billion euros and typically traded with a 22 multiple. It still pays out a strong 6% dividend and analysts expect the bank's earnings to rise in 2016 to between 0.66 and 0.70 euros per share, and achieve as much as 20% growth per year over the next five years. Even on the low end, that gives the stock a price-earnigns ratio of less than 10 today and, if successful, a per-share profit rate north of $1.80 at current exchange rates. Additionally, if the planned 40% dividend payout is kept as the levels are reached, owners of the stock today would enjoy an 11% annual dividend.

The downside risk is already baked in at this point

Back in 2014, the bank paid $117 million to acquire Simple, an online bank that operates without any physical branches and appeals to millennials. The goal was to move more into technology-driven banking with a financial technology company. Since making that purchase however, the bank has taken a goodwill impairment charge on its earnings with a total write-down of $89.5 million since the acquisition. On the most recent earnings call (Feb. 1) with analysts, BBVA CEO Carlos Torres Vila said Simple "is growing very well," adding more than 30,000 customers a month. This could be the long-term pivot the bank uses, but for now it is not much else.

The real value is going to come from growth in South America, Turkey and the United States. Mexico is one of the least penetrated banking systems in the world with a loan to GDP rate of 31%. This ratio should increase as Mexico will be forced to look inward if U.S. trade policies tighten and tax countries south of the border. BBVA has incredible efficiency ratios and return on equity rates in Mexico, which put it in a very good position to counteract any poor policy by the country's trade partners. Currently, the bank generates about 40% of its net income from Mexico.

If the growth rate is even half as good over the next five years, the bank would be in a position to earn 1.13 euros per share. If the euro regains any ground back to $1.15 or $1.25 per euro, that could translate into a stock price of $14 to $15 at current price multiples, and prices in the high 20s to low 30s at historical multiples. Again, this is just a big guessing game at this point, but investors can rest easy with a 6% annual dividend that will likely grow over time. That alone is enough margin of safety for a big bank like Banco Bilbao.

Disclosure: I have no positions in BBVA.

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This article first appeared on GuruFocus.


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