Deutsche Bank Stock: Attractive Business Mix (NYSE:DB)

Following our update on UniCredit-Commerzbank, today we return to comment on Deutsche Bank Aktiengesellschaft (NYSE:DB). Since our buy rating, the company has continued its restructuring progress and combined with a favorable interest rate medium, as anticipatedthe DB share price has returned to a satisfactory level with a total return of 59.33% since June 2023 (Fig 1).

Fig 1

Before we give our view on the bank, reporting the latest numbers from DB’s home market is vital. In addition, we provide an update on the potential Commerzbank-UniCredit merger and its significant implications for Deutsche Bank. Starting with Germany, corporate insolvencies are on the rise, once again signaling the crisis affecting Europe’s largest economy. According to Destatis, corporate bankruptcies rose by almost 25% to 10,702 reported cases compared to H1 2023. Even in August, the number of declared ordinary insolvencies increased by 10.7%. In total, we are talking about 32.4 billion euros in damages compared to last year, which was around 13.9 billion euros. In detail, looking at the sector, transport, storage and construction were the divisions mainly affected.

Linked to the Commerzbank-UniCredit transaction, the combined entity could become the first direct lending player on the German banking market. This could put pressure on Deutsche Bank’s margins due to greater price competition. In addition to the lending space, asset management could also be at risk. In addition, regulators may compare Deutsche’s capital adequacy with this new entity, leading to additional capital requirements. This could be detracting from expected shareholder remuneration. In addition, Deutsche Bank may need to reconsider its restructuring strategy, accelerating its cost-cutting plan. If the UniCredit-Commerzbank deal goes ahead, it could strengthen EU banking assets and set a precedent for other mergers. Deutsche Bank may be pressured to explore similar consolidation opportunities. All in all, in our forecast numbers, we anticipate a limited impact of this potential merger agreement. Here at the lab, we are more concerned about Germany’s economic challenges than the potential pressure of greater competition. That said, this deal could force the company to increase its efficiency and reconsider its market positioning.

Q2 results and our positive take

In the quarter, the bank achieved sales of 7.6 billion euros, which was a plus 2% ahead of the company’s consensus. Looking at first-half results, the company achieved print revenue of €15.4 billion, putting DB’s €30 billion turnover target within reach. In addition, the CEO expressed confidence that Q2 2024 will be stronger than Q1, supported by the CIB market gain. In Q2, excluding the provision for Postbank disputes, DB’s PBT reached €1.7 billion against a performance of €1.4 billion achieved in Q2 2023. After fee and commission income increased by 12%, the company still waiting for better development in Private Bank and Asset Management. Additionally, as reported in the analyst call, this is not due to higher AuM, but higher fees. In S1, the company reported adj. costs fell by 2% to EUR 10.1 billion. In Q2, adj. costs came in at €5.04bn and were in line with consensus estimates, but up 2% year-on-year. This was due to increased wages and higher compensation, partially offset by the CIB division’s efficiency measures. The main German bank reported a CET 1 ratio of 13.5%.

Source: Presentation of DB Q2 results – Fig 1

Here at the lab, we are still positive for the following reasons:

1. On top of 2% better sales and in-line costs, pretax profit was just 4% above consensus. This was due to the lack of provisions for loan losses; however, we believe this is temporary. Starting in fiscal 2025, the CEO is confident of a generation of sustained growth. For this reason, and despite an unfavorable interest rate environment, we still forecast sales growth of 4% to €31 billion. Compared to most other EU banks, the company derives less than 50% of its sales from NII, and with ECB cuts, we believe Wall Street will favor less NII-dependent banks and more diversified groups. We should also report that fee income generation, including the ECM and M&A divisions, could accelerate with rate cuts. In addition, in our estimates, we have aligned the cost of DB risk to 40 basis points (as EU bank coverage); this is just above the 30 basis points of the company’s internal guidance;
2. The cost-income ratio reached 69% compared to a production of 73% in the previous year. Deutsche Bank anticipates that operating efficiency will approach a quarterly rate of around €5 billion. In our view, this goal is achievable and the company should limit exceptional items to regain investor confidence. That said, the CFO confirmed that he can start with a clean 2025. Therefore, we could expect additional restructuring charges in Q2;
3. Given the company’s guidance (Fig 3), from a 2024-2026 capital distribution perspective, we are above the €8bn target. In figures, including the buyback and assuming a DPS of €0.68/1.00/1.25 in 2024/2025/2026, DB is likely to distribute €9bn. This implied that DB would return > 30% of its market cap. This scenario is supported by RWA optimization of €4 billion and DB’s CET1 ratio could exceed 13% in the cycle.

Fig 2

Fig 3

Changes and assessment of earnings

Our forecasts are slightly lower than DB’s outlook for 2024 as we incorporate the higher cost of risks and potential additional costs in the company’s restructuring process (Fig 5). We believe that DB sales in 2024 of EUR 30 billion are achievable, and our pre-tax profit in 2024 has reached EUR 5.9 billion. This includes a total annual provision forecast of €1.6 billion (credit losses in Q2 reached €476 million). We reach 3 billion euros in earnings, with an EPS of 2.4 euros. However, the attractive business MIX offers significant potential for revaluation. DB is still cheap in our estimation. In detail, the P/TBV is still at 0.5x and looking at the 2025 valuation, DB is trading at a P/E of 4.5x with a P/TBV of 0.45x. This bank has an achievable ROTE of nearly 10% and a potential market cap distribution of 30% over the next three years. The EU banking sector trades at a higher multiple (P/E of 7.0x and P/TBV of 0.9x). At a 20% discount to peers and applying a combined valuation methodology with a P/E of 6x and a P/TBV of 0.7x, we value the company with a target price of €17. We have therefore affirmed our Buy rating.

Fig 4

Fig 5

risks

DB is exposed to the German and American markets, given its activity in the CIB division. The company’s profit generation is also subject to deterioration in credit quality. That said, even if the home country isn’t performing well, 70% of DB’s exposure is mortgage-related. This limits the company’s credit risks. However, a slowdown in the German savings industry could lead to lower net fees. In commercial RE, the company has limited exposure. In addition, DB has a CET 1 ratio of over 13%. The Group’s downside is also related to interest rate developments, operational risk (cyber security), exchange rate fluctuations and regulatory changes (such as the new Basel 4 requirements). As reported above, a merger between UniCredit and Commerzbank could put pressure on DB’s margins.

Conclusion

There is a mix of supportive fundamentals and higher shareholder pay. Furthermore, despite a positive trajectory in CET 1, cost/income ratio and less reliable NII, the company still trades in the lowest quartile compared to its EU peers. For this reason, our overweight status is valid.