Stocks and Shares

Deutsche Bank: once more down in the dumps

Deutsche Bank stock must be one of the most-hated stocks in the markets these days. In the past couple of weeks it’s traded down to new lows. But, if new management can continue to turn around the underlying business in coming years then the stock is absurdly cheap. There’s still potential for massive profits for those prepared to ignore short-term price swings and sit it out for a few years.

I first highlighted the beaten-down stock of Deutsche Bank (XETRA:DBK / NYSE:DB) back in July 2016. The bank was struggling to make a profit and there was a good chance it needed a capital raise.

But, assuming management could eventually get things back on an even keel, the stock looked like a bargain for those prepared to hang in there for a few years. I said it would probably take three to five years to pay off, and we’re now coming up to two years.

At the time, the stock traded at €11.81 / $13.89. After some initial jiggling about, and an eventual rights issue in early 2017, it rose as high as €17.19 / $19.05 in May 2017, up 46% in euros and 37% in US dollars. Things were working out well.

However, the price then fell again, before peaking again at €16.92 / $19.89 in December 2017. That was up 43% in both euros and dollars since the July 2016 recommendation. Again, things looked on track.

But since then, throughout 2018, the stock price has done nothing but fall. Below is a chart which shows the price in euros over the past two years.

There has certainly been bad news of late, but nothing on a magnitude that justifies this new price collapse. It’s true the bank reported another accounting loss in 2017. But that was due to a one-off technical accounting entry, to do with the write-down of deferred tax assets, following reduced US corporate tax rates. In the long run, the reduced rates mean a lower tax bill, which is actually a positive thing.

Then the bank got into a public management spat, which eventually led to the ejection of CEO John Cryan. This was a pity, since it’s widely acknowledged that Cryan was essential in overseeing the resolution of many of the bank’s legacy issues. Those included major litigation cases and multi-billion dollar regulatory fines in the US, undercapitalisation of the balance sheet, poor technology systems, poor risk controls, and an overly complex business structure.

At the same time, first quarter results were nothing to write home about. But, neither were they a complete disaster. Profitability remains weak, that much is absolutely clear. But the business is mid-way through a multi-year turnaround, so nobody should expect miracles just yet.

On 24th May, the bank held its Annual General Meeting (AGM). That gave shareholders a chance to hold management feet to the fire. Some upset shareholders made their own proposals to the meeting.

Those included sacking the bank’s Chairman, Paul Achleitner. Not least since he’s been overseeing all the trials and tribulations since 2012, and many think he mishandled the recent change of CEO. Another proposal sought to break up the bank. But all such demands were rejected by over 90% of the votes cast.

At the meeting, certain details of future plans were laid out by the new CEO Christian Sewing, a 30 year veteran of the bank. Most significantly, he stuck to the target of reaching a return on tangible equity (ROTE) of 10% or more from 2021 onwards.

Sewing also outlined plans to reduce the staff in the investment bank division, especially in the equities business and in the US. Overall, total bank staff numbers will be cut from 97,000 to around 90,000, a reduction of 7%. More details of plans and financial targets have been promised soon.

Usually, sticking to the medium-term profitability target and cutting costs in underperforming businesses would be seen as good things. But the stock price fell. Although – it should be noted – it was during a week when European stocks were hit in general, given the political uncertainties in Italy (couldn’t form a government) and Spain (kicked out a government).

Second quarter results won’t be published until 25th July. I’m expecting a modest profit, but nothing either spectacularly good or dramatically bad. In any case, it’s the longer-term trajectory that should matter for investors.

The current stock price is €9.42, equivalent to $11.02. To get an idea of just how cheap that is, it should be compared with something called tangible book value per share (TBVPS).

“Book value” refers to net book value of the bank, also known as net assets or shareholders’ equity. It’s all the company owns less all it owes. “Tangible book value” strips out goodwill assets, which are an accounting entry related to past corporate acquisitions, and is also known as tangible equity. TBVPS just divides that by the number of shares.

At the end of March 2018, TBVPS stood at €25.70 ($30.07). Effectively, that’s a good proxy for the liquidation value of one single share. If the bank was shut down today, all assets were sold, and all liabilities were paid, that’s roughly the amount that shareholders would receive for each share owned.

Assuming TBVPS is the same today as the end of the first quarter (and it’s probably a little higher), that means the stock trades with a price-to-tangible book value (P/TB) ratio of just 0.37 (€9.42 divided by €25.70). Put another way, Deutsche Banks’s liquidation value is 173% higher than the current market capitalisation of all the shares.

Looked at another way, I estimate the current price factors in an ROTE of just 5.4%, give or take. That’s more or less what the bank’s businesses already achieve. In other words, the market is taking no account of a future improvement in profitability. This seems excessively pessimistic to me.

If the bank does eventually reach its ROTE target of 10% a year, then the stock should trade at a much higher P/TB multiple. I estimate it should be around 1, which would bring the price into line with liquidation value (+173%). Even if only 8% ROTE is reached (and remember…new management has promised more than that), the stock should trade around a P/TB level of 0.67. That’s still 81% above where it is today.

A stock for contrarians

Either way, all the signs are that significant profitability improvements will still take at least a couple more years. In the meantime, the tangible book value itself will grow a bit, as profits are retained and added to capital. Plus, there will be modest dividends too.

In other words, Deutsche Bank remains a stock that could easily double investors’ money over the next two to three years, and perhaps triple it.

The recent big falls in the stock price have nothing to do with a fundamental deterioration in the bank’s capital, liquidity position or business prospects. Instead, they have everything to do with deeply negative, short-term market sentiment.

This stock is not for the faint-hearted, and it never was. After all, it’s still a leveraged banking institution, and (genuine) negative surprises are always possible. That said, the business mix continues to shift away from the riskier investment bank over time, and towards the more stable businesses of retail / commercial banking and asset / wealth management.

Investors in Deutsche Bank should continue to expect plenty of stock price volatility. But patient, contrarian investors will do very nicely if, or when, it eventually completes its turnaround and today’s negative headlines fade into the past.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com


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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.