At the risk of sounding like a broken record, I'll say once again that long-term, risk-tolerant investors should have at least some exposure to emerging markets. More specifically, I think investing in companies catering to the rapidly growing middle class in developing countries is the best way to gain such exposure and offers the most potential bang for your buck.
I've touched on a couple of these companies in past articles, including fast-growing banking plays such as India's HDFC Bank
That said, I realize that some investors might not be comfortable with the level of risk such pure-play emerging-market stocks carry. After all, the Asian financial crisis occurred less than 10 years ago, and this past May wasn't exactly kind to investors with significant exposure to developing markets.
Well, how about a compromise? What would you think about a banking stock that offers significant exposure to rapidly growing emerging market countries and the stability (and tasty dividend income) that comes from a leadership position in the world's more developed markets?
No, I'm not talking about Citigroup
I know, I know: Global interest rates are rising, and rising interest rates are often problematic for banks. For one thing, they tend to harm net interest income, while increasing the chance of credit defaults by customers. Furthermore, I'm aware that Banco Santander's Latin American operations -- a significant source of growth -- expose the company to currency translation risks. The weakening of these currencies versus the euro is, indeed, something to keep an eye on. Lastly, while the integration of Abbey National (acquired in 2004) has proceeded smoothly so far, execution risk does remain in the form of lower-than-expected cost synergies or unforeseen asset liabilities.
Sounds like I'm backtracking on my original assessment, doesn't it? Not in the least. In my Foolish opinion, the risk/reward ratio remains firmly in Banco Santander's favor, thanks to the company's strong positions in the dynamic U.K. and Spanish markets, its growing presence in those "risky" Latin American countries, and a history of operational excellence.
Let's take a look at the company's books, so to speak. (Note: For currency translation purposes, one euro = $1.27.)
Banco
Santander
As I mentioned previously, Banco Santander, formally known as Banco Santander Central Hispano S.A., is the second-largest bank in Europe in terms of market capitalization (after HSBC Holdings). It's also the biggest financial group in Spain. As of Dec. 31, 2005, the company had total assets of roughly $1.03 trillion, served more than 35 million individual customers in the United Kingdom and Latin America alone, and had more than 10,000 branches worldwide.
The company operates in three divisions: Retail Banking (77% of pre-tax income as of June 30), Global Wholesale Banking (14% of income), and Asset Management & Insurance (9%). Given my investment thesis, I'm more interested in the geographic breakdown of Santander profits for the first half of 2006: 51% came from continental Europe, 34% came from Latin America, and 15% came from England via Abbey National, which was acquired by Santander back in November 2004 for roughly $15 billion.
Simply put, one of Santander's greatest strengths is the potent blend of growth and stability offered by this geographic mix of Old World and New World business.
The Old World
Since Santander derives 66% of its revenue from what could be termed "developed" countries, investors can take some comfort in a relatively predictable stream of income (and the cash generation which supports Santander's 3%-plus yield).
That's not to say that growth in the Old World is in any way lacking. Santander's operations in continental Europe, powered by growth in the dynamic Spanish market, reported an 11.5% gain in profits (to $2.2 billion) in the first six months of the year. And the U.K. business, Abbey, racked up $624 million in pre-tax earnings, a 40% increase over the same period in 2005, due to both organic growth and tight expense control.
This type of growth would be impressive even coming off a small base, but Santander isn't exactly a small player -- it holds the No. 1 position in the Spanish market and is the No. 2 player in the U.K. retail banking market. In a mature market such as Europe, scale is king, and Santander sure has the footprint to fit the bill.
The New World
Now, if Santander only operated in Europe, it would still be an attractive company. But it also gets an extra bit of kick because it derives more than a third of its profits from the rapidly growing economies of Latin America. In the first half of 2006, Santander's Latin American operations kicked in roughly $1.5 billion in pre-tax profits, a 27% increase over the same period last year. The company benefited from strong lending growth in Mexico, Chile, and Brazil, as well as a favorable exchange rate environment.
Santander holds a pretty significant (and growing) share of its target markets in Latin America -- Brazil (5.6% market share), Chile (23%), Mexico (17%), Venezuela (15%), and so on. Given this, I believe the company will continue to reap rewards as the top international player in a region where economic growth remains strong (estimated to be in excess of 4% in 2006), interest rates are actually falling (Mexico and Brazil), and the middle-class consumer is coming of age.
Of course, having a diverse mix of businesses isn't a formula for success if the company isn't able to execute. Fortunately, Santander seems to have its bases covered in spades, as a quick look at a few of its recent operating metrics will illustrate.
Operational excellence
Despite the challenges posed by managing a geographically varied mix of businesses, Banco Santander continues to drive operating efficiencies. In the first half of 2006, the company posted a return-on-equity of 18.2% (up from 16.2% in the same period of 2005), a return-on-assets of 0.87% (compared to 0.80%), and an efficiency ratio of 48.5%, a 450-basis-point improvement over the first half of 2005.
Not too shabby, eh? Especially when you consider that the company has also been able to lower its non-performing loan ratio to 0.83% from 0.98% last year.
Valuation
At a recent price of $15.50 per American Depository Share, shares of Banco Santander trade at around 10 times fiscal 2007 estimates of $1.50, a 20% discount on the company's projected long-term earnings growth rate. Given its proven operating efficiency, the company's exposure to the rapidly growing consumer markets in Latin America, and the stability of its European operations, I believe investors should consider banking on Santander's continued growth.
More global banking Foolishness:
- Banco Itau: Cashing In on Brazil's Growth
- Lloyds: Good News and Bad
- Is HSBC the Go-To Bank for Global Investors?
- HDFC Banks on India's Growth
Fool contributor Will Frankenhoff is enjoying his time writing for the Fool more than reading The Financial Times, rooting for the New York Giants, or pondering the vagaries of life (pretty unsuccessfully up to this point). He welcomes your feedback at [email protected]. He does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.
