(Bloomberg) — European banks have sailed through the earnings season and are promising massive share buybacks, adding fuel to their best winning streak since 1997.
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The sector has been rallying for nine straight weeks and is by far the best performer in Europe this year, up 18%, led by Societe Generale SA and Banco de Sabadell SA. Banks have proved that falling interest rates are not denting their business, while a resilient economy and big share buyback programs are adding to the momentum. The ongoing consolidation of the industry is another tailwind.
“The European banking sector is leading the equity market rally for good reasons,” said Roberto Scholtes, head of strategy at wealth manager Singular Bank, pointing to fourth-quarter earnings beating consensus expectations by roughly 10% on average. “Looking forward, all these trends are likely to remain in place.”
The sector entered the earnings season with high expectations after extending a rally that began in late 2020, with the benchmark Stoxx 600 Banks having more than tripled since then. While some firms saw setbacks in results as costs rose alongside revenue, investors were quick to buy the dip. UniCredit SpA and Barclays Plc have already recovered from last week’s post earnings drops.
“On a cumulative basis all banks have beat on income, 89% on pre-provision profit and 79% at the profit-before-tax level,” said UBS Group AG analysts led by Jason Napier, who are staying overweight on the sector. “With better revenues it’s not surprising that costs are coming in higher.”
The consolidation in banking is also driving stocks, with a flurry of dealmaking in a quest for scale and lower costs. Italy is leading the way, with UniCredit SpA making a move on smaller rival Banco BPM SpA, which itself is in the process of buying Anima Holding SpA. Banca Monte dei Paschi di Siena SpA has made a hostile offer for Mediobanca SpA, while BPER Banca SpA is going after Banca Popolare di Sondrio SpA. In Spain, Banco Bilbao Vizcaya Argentaria SA has a takeover play on Banco de Sabadell.
While the stocks involved in these deals are among the top gainers this year, they are not the only ones. France’s Societe Generale is the best performer in the Stoxx 600 Bank Index, surging over 40% after being a laggard over the past two years.
Investors are convinced the rally has further to go. According to a Bank of America Corp. fund manager survey published earlier this week, banks are now the largest overweight in Europe for the first time since July 2023, and the sector is still considered one of the most undervalued. More broadly, financials are expected to be among the best performers this year, the survey shows.
Share buybacks unveiled during earnings are providing another major boost. Financial firms have been the biggest contributor to repurchase programs announced since the start of the year. That means banks look set to be the largest provider of shareholder returns once again this year, after accounting for nearly a fifth of the dividends and buybacks of Stoxx 600 companies in 2024.
The rally has brought a major re-rating that means the sector is not as cheap as it used to be. The forward price-to-book ratio for the Stoxx 600 bank index is approaching the top of a 15-year range, while the forward price-to-earning ratio is the highest in two years.
“Looking back over the past 25 years, periods of bank outperformance have ended when valuation levels have reached stretching point,” said Keefe, Bruyette & Woods analysts led by Andrew Stimpson, citing 10 times forward earnings and an 80% relative P/E as the stretched levels. “That would mean upside of about 30% from here.”
They are also staying overweight, though warn “things rarely go in a straight line.” Seeing out the next leg of the rally will need a lower cost of equity and some belief in a small amount of growth in the region.
While it’s hard to find people who are negative on the sector, JPMorgan Chase & Co. strategists are underweight on banks. They see vulnerability to peaking earnings, and to lower rates from central banks.
From here, the shape of the economy will be important. Forecasts point to 0.9% growth for the euro area in 2025, though there’s uncertainty over the possibility of a trade war. While the European Central Bank is expected to cut rates three more times this year, which would impact margins for lenders, its approach has been cautious. The bond yield curve has been steepening, a good omen for the sector.
“Banks in particular have been a good example how a turnaround in macro/earnings regime and self-help (buybacks) can boost profitability and subsequently valuations,” said Barclays strategists led by Emmanuel Cau. “They still have considerable room to improve on their valuations.”
–With assistance from Macarena Muñoz.
(Updates with M&A details in sixth paragraph, top gainers in seventh paragraph)
