Why French banks might be a buying opportunity - part 2

As we argued yesterday, the “three musketeers” of the French banking industry, BNP Paribas, Credit Agricole and Societe Generale, might have regained earnings momentum, although from low levels, and could therefore surprise positively going forward. Judging from the share price performance since the peak last summer, the stock market is yet to buy into this, chart 1.

Valuation wise, it is still much cheaper to buy banking earnings in France than Europe as a whole. The measure we use to assess the valuation is the 12 month forward P/E ratio. Based on this measurement, Credit Agricole (ACA) is valued at 5 times earnings in the next 12 months, Societe Generale (GLE) at 6.4 times and BNP Paribas (BNP) at 6.5 times. The average for Europe, here represented by the Euro STOXX banking index, is 8.1 times, i.e. French banks are trading on a 25-62% discount on earnings, chart 2 and Chart 3. This indicates that French banks can be undervalued. To look further into this we have to take a look at the valuation of the book value.


Are French banking stocks undervalued?
Since last summer, the French banking valuation has been particularly plagued by PIIGS events.

French banks have significant exposures to both Greece and Italy, and French banking shares got treated as being in the core of the crisis.

Many banking analysts, including myself, were concerned about that the Italian situation would go from bad to worse and the problems would spread among all the banks being exposed, especially due to the extensive Italian bond positions being carried on the French banks’ balance sheets.

The short-term risks in Italy have to date diminished, at least according to the CDS market. Few can argue that the Greece situation has been sorted out; however, most of the engagements have been written off.

So, why are French banks traded at a hefty discount to their peers, especially the British and Italian ones? See chart 4.

Yes, that could be the case!
The basic take from this is that there is not any clear logic in the current valuation situation, other than that the market is anticipating risks that the French banks will have to announce further capital increases to meet the Basel 3 standard.

I don't see that happening, but even if it does, the “Three Musketeers” from France have a good potential to surprise on the upside if we are not hit by yet another shock in Europe in the coming months. And again, how knows anything for sure in this kind of market?