Investment thesis

Societe Generale (OTCPK:SCGLF) exceeded my expectations in the fourth quarter of 2021 and despite the operational headwinds in 2022, I think the recent correction creates a buying opportunity, but with a number of short-term risks such as French presidential and legislative elections this year. Additionally, Societe Generale lagged the other struggling group in the European banking space, namely German banks, with Commerzbank (OTCPK:CRZBF) and Deutsche bank (DB) gaining 37.7% and 23% in just 50 calendar days. . Clearly, such large gains create a very high risk of a short-term correction across the banking space, which should end up being a buying opportunity, with the caveat that the gains are already behind us and that investors should start looking for alternatives. Nevertheless, until something more convincing happens, buybacks and undemanding valuations should create an acceptable risk-return opportunity for European banks and Societe Generale in particular.

Company presentation

Societe Generale operates in three key divisions, namely Retail Banking in France, around 31% of Group NBI in Q4 2021, International Retail Banking and Financial Services at 32.6% of Group NBI in Q4 2021, and Large Customers and Investor Solutions at 35%. of Group Net Banking Income in Q4 2021:

Operational overview

The fourth quarter ended an excellent year 2021, with a RoTE of 9.2% for the last quarter of the year. However, this is a deterioration compared to the RoTE of 10.2% achieved over the whole year:

A red flag for the ROTE reached is that in reality in the fourth quarter of 2021, the cost of risk, at 6 basis points, was lower than the 13 basis points reached for the full year. Management’s expectations for 2022 are for a cost of risk of less than 30 basis points. This is a conservative forecast, consistent with the cost of risk in 2019 – at 25 bps, and 2018 – at 21 bps. Overall, it can be said that the cost of risk should at least double in 2022 to reach 1.4 billion euros. With an income tax rate of around 21%, I expect the €700 million increase in the cost of risk to reduce profits by around 13%. Altogether, an 8% RoTE for 2022 best resembles what is achievable in a positive scenario. However, some benefits could come from the continued release of Stage 1/Stage 2 provisions, which remain high compared to 2019 levels:

Capital situation

During the conference call, Chief Financial Officer Claire Dumas confirmed previous predictions for the impact of Basel IV of 35 billion euros in risk-weighted assets (RWA) and less than 115 basis points of risk-weighted assets. impact on the CET1 ratio. The current pro forma cushion of 450 basis points of maximum distributable amount (MDA) is sufficient to absorb the expected headwinds for 2025:

I will now highlight the valuations of majority-owned subsidiaries such as car rental company ALD (79.8% stake SocGen), Romanian bank BRD (60.17% stake SocGen as of September 30, 2021) and Czech bank Komercni Banka (60.4% SocGen stake).

ALD

ALD recorded a record Q4 2021 and its operating results actually improved slightly compared to Q3, with a net result of 262.8 million euros:

However, the used cars result, at EUR 2,607 in the fourth quarter, is significantly higher than management’s forecast for 2022, above EUR 1,000/car:

Overall, it is safe to expect that ALD’s performance in 2022 will be materially below 2021 levels, impacting the optimistic RoTE scenario by 8% in a cost of risk result of 25 points basis for Societe Generale in 2022 that I described above.

ALD ended 2021 with shareholders’ equity of €4.812 billion, including €665 million of intangible assets. With a market capitalization of around €5.6 billion at the time of writing, Societe Generale’s stake is worth around €4.47 billion.

The big novelty of 2022 was certainly the proposed takeover of LeasePlan by ALD. You can check out my full article here.

In this article, I will update my calculations with fourth quarter results for ALD at the time of writing. The main idea is that ALD buys LeasePlan, which will have to maintain a book value of approximately 3.5 billion euros, for a combined consideration in cash and ALD shares:

Making up	Billions of Euro’s	ALD share price, EUR/share	ALD-shares
Cash	2	Not applicable	Not applicable
Shares	3.3	13.9	239 273 927

Source: Author’s calculations and estimates

Since last month, due to the slight decline in ALD’s share price from EUR 14.32 to EUR 13.9, the Equity component of the trade has improved slightly for ALD by around 100 million of EUR.

Finally, regarding the current assessment of the parties involved:

Company	Premium/Discount over book value, current trading
LeasePlan	+51%
ALD	+16%
Societe Generale	-53%

Source: Author’s calculations and estimates

Since the previous update, the deal actually looks slightly worse for Societe Generale given the stellar book value growth achieved in Q4 2021. Overall, I’m still not confident that ALD will deliver, consistently and in the long term, a RoTE 2 to 3 times better than Société Générale Générale to justify the operation from Société Générale’s point of view. Nevertheless, the 5% increase in earnings (after Societe Generale’s proposed buyout later this year, I believe the increase will be closer to at least 5.2% due to the reduction in the number of shares ) in 2024 thanks to the deal will be something good, and the new structure will create a valuable listed asset for Societe Generale.

BRD

BRD is well received by the Romanian market where the shares are trading, with the price currently close to the 52-week high of 21.55 RON:

With a market capitalization of around RON 14.496 billion against a book value of RON 9.821 billion, the stock is trading at a steep premium to book value (P/B 1.48).

Societe Generale’s 60.17% stake is worth around 1.76 billion euros at the current exchange rate of 1 EUR = 4.9453 RON.

Komercni Banka

Komercni Banka trades on the Prague Stock Exchange and, like BRD, trades at a good premium to book value (P/B 1.48):

With a market capitalization of CZK 183 billion, Societe Generale’s 60.4% stake is worth approximately €4.55 billion at the current exchange rate of 1 CZK = 0.0412007 EUR.

to summarize

The most visible profitable companies add up as follows:

Company	Value of Societe Generale interests, billions of euros
ALD	4.47
BRD	1.76
Komercni Banka	4.55
Total	10.78

Source: author’s calculations

Faced with Societe Generale’s market capitalization of approximately 27 billion euros, these three activities represent a tangible means of generating approximately 40% of the market capitalization, thus rebalancing the gap in book value between the parent company and the subsidiaries held mostly. Of course, it should be noted that these are the most profitable segments of the bank, and any monetization should be done in an orderly fashion over several years, in particular with the proposed ALD-LeasePlan operation in which Societe Generale s is now committed to remaining a long-term shareholder, thus tying up investors’ capital for several years to come.

Key takeaway for investors

Compared to 2021, Societe Generale’s operational performance will deteriorate in 2022 before cost improvement projects begin to bear fruit in 2023-2025. Nevertheless, valuation is undemanding in a positive interest rate environment for banks. While an industry-wide correction seems overdue, over the medium term the fundamentals are in place for a continued upward drift in the stock price, albeit at a much slower pace than seen in 2021. Personally, I will continue to roll my option positions with an upward bias.

Thanks for the reading.