Deep value is rarely found soaring about in blue skies and unbridled optimism. More typically, it’s found floundering in sludge and soul-breaking pessimism.
Germany’s largest bank, Deutsche Bank AG (NYSE: DB), is floundering in sludge. What’s more, Deutsche Bank’s performance – both its share price and financials – have broken many investors’ souls.
Deutsche Bank shares have traded on the New York Stock Exchange since 1996. Back then, an investor could have picked up a DB share for $45.[ad#Google Adsense 336×280-IA]In early 2007, he could have sold that share for $145.
Since then, it’s been a wingsuit flight down from the stratosphere to terra firma.
Today, DB shares trade for less than $18 each – an all-time low.
Deutsche Bank’s problems are as varied as they are numerous.
Business is down across its two largest divisions.
Its corporate banking and securities division reported a 30% year-over-year decline in the fourth quarter. Its private and business clients division reported a 7% decline. European economic stagnation weighs heavily on both.
Capital structure is another issue. Deutsche Bank’s common equity Tier 1 ratio, a measure of financial strength, dropped to 11.1% at the end of 2015, down from 11.5% at the end of September.
More than anything, though, Deutsche Bank has had difficulty keeping its nose clean. It has been plagued by a string of scandals, ranging from interest-rate manipulation to money laundering, that date back to 2008. Deutsche Bank has racked up 13 billion euros ($14.2 billion in current dollars) in legal fees and fines over the past seven years. More than a third of the money spent – 5.2 billion euros ($5.7 billion) – was spent last year.
All the bad news coalesced in 2015. Deutsche Bank posted a record loss of 6.8 billion euros ($7.4 billion) for the year. Bonuses for the management board have been eliminated, and bonuses for eligible employees will be reduced.
So, why do I like what’s currently the world’s worst bank?
For one, no matter how bad it gets, Deutsche Bank is going nowhere. It is Germany’s largest bank, and it’s too big to fail. To be sure, things could get so bad that the bank would need to undergo a complete capital restructuring that eliminates shareholder equity. I view that scenario as remote. More likely – though unlikely – Deutsche Bank would need to issue additional shares to raise capital. CEO John Cryan has assured investors that won’t happen.
Speaking of Cryan, he was brought on board last July to remake the company. Cryan specializes in large-scale remakes. He climbed the ranks at UBS AG (NYSE: UBS) to become one of its most senior investment bankers. As the financial crisis mounted in 2008, UBS promoted Cryan to chief financial officer, where he helped slash the Swiss bank’s balance sheet and resurrect its operations amid a government rescue.
Cryan is leading a push to simplify Deutsche Bank by selling risky or less profitable businesses. The company has already exited Russia, and it’s cutting its Brazilian workforce in half. It plans to drop in-house and contractor jobs, and eventually spin off its Postbank retail bank.
But it’s not just about cutting. Cryan will spend millions of euros this year to modernize Deutsche Bank’s important equity-derivatives and debt-trading platforms.
2015 was a “kitchen-sink” year. I suspect that everything Deutsche Bank could write off in 2015 it did. This makes sense. A new management team wants to remove as many legacy costs as it can and start anew. The stage is then set for future earnings.
Despite recent travails, Deutsche Bank is expected to make money this year. The average estimate is for $2.25 per share. If the estimate holds, DB shares are trading at less than 8 times forward earnings. Both Wells Fargo (NYSE: WFC) and U.S. Bancorp (NYSE: USB) trade at 11 times forward earnings. JPMorgan Chase (NYSE: JPM) trades at 9 times forward earnings.
Deutsche Bank’s depressed shares trade to yield 4.7%, based on last year’s dividend. (Deutsche Bank pays its dividend annually, which goes ex-dividend in May.)
There’s a chance a dividend might not be forthcoming this year. It depends how quickly the company can turn its operations around.
That said, expectations might be Deutsche Bank’s most attractive feature. There aren’t any. The bar is set at a floor-scraping low. Any positive news – even trivial positive news – will help lift Deutsche Bank shares out of the sludge.
— Steve Mauzy[ad#wyatt-income]
Source: Wyatt Investment Research