Deutsche Bank: A Contrarian Stock With a Contrarian Strategy

Deutsche Bank gets no investors love, so it's trying a contrarian strategy.

May 24, 2014 at 8:53AM

When it comes to big banks, Deutsche Bank (NYSE:DB) looks like the ultimate contrarian pick. Between a low valuation, capital concerns, and significant risk surrounding the eurozone economy, this German bank isn't able to catch a break from the market.

But at the same time as Deutsche Bank shares looks like a contrarian bet, the bank itself is taking a business strategy drastically different from current industry trends.

Bargain bin
Whether looked at from a book value or a price-to-forward-earnings perspective, Deutsche Bank looks to be one of the cheapest banks in the industry.At only 0.55 times book value, shares of the bank trade at levels below that of the two cheapest U.S.-based major banks, Citigroup (NYSE: C) and Bank of America (NYSE: BAC).

However, Deutsche Bank offers something Citigroup and Bank of America have yet to match.

With a 2.6% dividend yield, Deutsche Bank wins decisively on the dividend front when compared with Citigroup's 0.09% yield and Bank of America's would-have-been 1% dividend before B of A uncovered an accounting error that threatens the dividend.

Deutsche Bank's dividend isn't bulletproof, but then again, no bank dividend really is. If the European stress tests find the bank in need of more capital, the dividend may be suspended to preserve capital.

However, the bank's history of tapping shareholders for cash through rights issues makes it seem more likely that Deutsche Bank would run a rights issue than cut its dividend.

From a forward earnings perspective, Deutsche Bank also carries a low valuation. The bank trades at only 7.8 times FY2014 earnings and 6.0 times FY2015 earnings based on estimates from analysts reporting to Nasdaq.

A new strategy
In recent weeks, British bank Barclays (NYSE:BCS) announced a major restructuring that would create a bad bank and, more importantly to Deutsche Bank, slash Barclays' fixed-income business. Investors cheered the moves by Barclays as the British bank looks to streamline operations and move away from businesses that have been underperforming for banks on both sides of the Atlantic.

But where Barclays sees retreat as the best option, Deutsche Bank sees opportunity.

The Financial Times reports that Deutsche Bank is busy hiring workers being cut from Barclays as it seeks to build a fixed-income side that can truly rival the most powerful U.S.-based banks.

However, growing the fixed-income business isn't free, and with stress tests coming up, Deutsche Bank announced an 8 billion euro capital increase done through private investment and a rights offering.

Although large profits remain difficult to earn in the fixed income business, success here has upside for the German bank. If it can effectively compete with Wall Street's strongest institutions, it could take on a global presence even as other European banks seek to sell off assets to pass the upcoming stress tests.

Deutsche Bank would not be a true contrarian pick unless there were some risks, and these are certainly worth considering before making an investment.

The largest risk is poor performance in the upcoming stress tests. If regulators find a capital deficiency at Deutsche Bank, the bank may be forced to cut its dividend or tap shareholders for more cash through a rights issue.

The bank also faces the risks of a slow eurozone economy. Although the economy appears to be on the rebound, conditions can change quickly, and banks are often the hardest hit. New regulations could also restrain future profits, and lawsuits from governments or private individuals could also affect earnings over the next few years.

The venture into the fixed-income business is also not without risk. Fixed income has been hampered by weaker margins, and it may be some time before larger profits begin to flow.

A unique opportunity
As Barclays exits the fixed-income business, Deutsche Bank is seizing the opportunity to expand its business and is funding it by tapping shareholders for cash. With Deutsche Bank shares trading just above half of book value and the forward P/E ratio being in the mid-single digits, these shares are clearly in value territory.

Although not without risks, Deutsche Bank is a very interesting play on a bank with a low valuation as it seeks to grow its global presence.

As the bank completes its latest capital raise, I will strongly consider initiating a position in this unloved German bank.

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Alexander MacLennan has options on Bank of American and Citigroup. The Motley Fool recommends Bank of America and owns shares of Bank of America and Citigroup. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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