With a checkmate move, this Under-loved Turnaround story might get Momentum
An Elevator Style Pitch (Thesis)
Since 2021, 2 years after its “Compete to Win” strategy under its new CEO Christian Sewing, Deutsche Bank earned a total of €13Bn+ pre-tax profit (v.s. ~€2.5Bn loss in Y19), with continued revenue growth and disciplined cost control. Its turnaround is no longer credible, it already happened.
Yet the market is slow to recognize its comeback. It trades at 0.45x TBV, 4x NTM P/EBT, and 5.5x NTM P/E today.
The Bank plans to flex its capital allocation muscle to amplify its mispricing. Its intention to return 50% (up from 30% in 2023) of profit to shareholders by 2025 translates to an annual 5-7% buyback at a 55% discount to TBV, while shareholders collect 3-5% annual dividends waiting.
The question is: Can DB deliver this, and if so will it finally checkmate the market?
Summary
In this research, you will first hear the thesis in 3 parts: how Deutsche Bank executed its turnaround, how the market doesn’t care (enough), and what its plan is to (attempt to) checkmate the market.
I then take a trip down memory lane and discuss the Bank’s past glory and trouble, to show that its turnaround plan addressed the right problem sets, and aimed for sustainable growth, not a transitionary one (or a lucky one riding macro tailwinds).
I review the valuation math with a focus on its planned shareholder distributions. I also share my thoughts about common banking concerns nowadays (e.g. CRE), to help you fully assess the investment case.
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2019 Turnaround Plan
Let us start the story in 2019. Fluctuating revenue and declining profit best describe Deutsche Bank from 2000 to 2018 (as the chart below shows). It lost its management discipline in pursuing lucrative profits and unsustainable growth by making outsized risky bets with unhinged regulatory risk appetites (more in a late chapter).
By 2018, Deutsche Bank was at a crossroads.
Christian Sewing took the helm that year in crisis. He joined DB in 1989 as a trainee, rising through credit and risk management functions, and heading private banking before his CEO appointment.
Labeled as “Compete to win”, Sewing unveiled DB’s turnaround strategy in early 2019, aiming for sustainable profitability by enhancing its core (CB) globally, focusing on PB domestically (Germany), cutting money-losing biz (e.g. IB), applying cost discipline, and unloading high-risk assets.
I call it Sewing gets back to Kopper* (Deutsche Bank)’s roots - a merchant bank facilitating international trades and a partner to corporate treasurers of large enterprises.
* Hilmar Kopper was an influential financier and the Chairman of the Board from 1989 to 1998. I included a fascinating interview he did in 1994, to dive into Deutsche Bank’s roots in his vision (last section).
Turnaround Worked
The “Back to DB root” strategy worked.
This chart shows a sharp difference before and after Sewing as CEO - steady revenue growth (v.s. crazy fluctuation) and steady and contained cost decline since Sewing took the helm.
The Market doesn’t Care (enough)
Interestingly (unfortunately for shareholders), the market doesn’t care enough.
Over the last 5 years, DB 0.00%↑ stock up 68%, only on par with XLF 0.00%↑’70%, and behind both SPY 0.00%↑ (100%) and JPM 0.00%↑ (111%), deviating quite significantly in terms of relative business vs stock price performance.
Despite the evident turnaround, the market questions whether the growth and profitability are sustainable. Let me take you to a detour to try to answer that question.
Past Glory and Troubles
Founded in 1870 (and traded on the Berlin Stock Exchange the same year), Deutsche Bank was the first company listed on the NYSE after 9-11. But its reputation has been severely dented by irresponsible risk-taking on complex financial products (e.g. CDO during GFC), various banking scandals (e.g. Libor rate-fixing scandal in Y12), allegations of money laundering, controversial clients (e.g. Trump, Epstein), and tense relationships with regulators.
In the mid-2010s, Deutsche Bank was commonly regarded as “the weakest link among GSIBs in the global financial system”.
An accumulated over 9Bn fines and settlement it paid since GFC, some examples:
In 2014, a $1.93Bn settlement to US FHFA, for its sale of subprime MBS to Fannie/Freddie Mac during GFC
In 2015, a combined $2.5Bn fines to US/UK regulators for its role in LIBOR-fixing scandal.
In 2015, $258Mn fines for trading with countries subject to US sanctions.
In 2017, $425Mn settlement for $10Bn money laundering claims in Russian funds.
In summary, DB’s trouble was largely attributed to its unhinged risk-taking behaviors (in both customer and complex financial product dealing, mostly in its IB-related biz). Its crown jewels, loan book quality, and core CB business, were intact.
That’s why I think its “Compete to Win” strategy, namely growing its corporate bank globally, focusing its private bank domestically, increasing fee-based steady revenue, shutting down non-core IB units, and isolating and unloading risky assets, attacked the right problem sets, and offered a path to sustainable/steady profitability.
Inflection Point to Checkmate the Market
The story up to this point is common: despite a heroic turnaround, the market doesn’t appreciate it. After all, reputation/perception is paramount and slow to change, especially for a bank. Management can talk/complain about it, the market could care less. But Deutsche Bank management is taking a step further.
In the 4Q23 conference call, Christian Sewing and James von Moltke mentioned the inflection point multiple times with a clear message: We stabilized and turned around the Bank from 2019 to 2023. The next step is to maximize shareholder returns.
From Christian Sewing (CEO):
We have now reached an inflection point on costs; our investments are approaching completion, and we are making solid progress on our efficiency program. As a result, we now see ourselves delivering normalized operating and financial performance.
Now with the investments which we have done, taking the regulatory increases into our capital in and digesting it, we can clearly see that we are at the inflection point on our franchise, but in particular also when it comes to our capital position. Now what does it mean concretely? And also there, Chris, if we compare this year to last year, last year in the January earnings call, we did not actually talk about and had the approval for a share buyback. You see our confidence overall in the way the bank has done and on which way we are, and therefore we ask for the approval of the €675 million last year. We got the approval now.
From James von Moltke (CFO):
At the end of the fourth quarter our leverage ratio was 4.5%, reflecting a lower capital position and higher leverage exposure. Building on Christian’s earlier comments on the inflection point in our capital base on Slide 17… First, in line with our ambition, we want to pay out 50% of net income to our shareholders. Second, we will aim to deploy about 25% of net income into the businesses to support further growth. Finally, we expect the remaining 25% will provide us with a buffer.
As we outlined last quarter, we have passed an inflection point in our capital management plan which supports our intention to distribute roughly half of our generated net income to shareholders, which, alongside with cost management, is our key management priority.
Here is one chart illustrating its past (since 2022) and projected shareholder distribution till 2026.
The intention is clear: the market ignored our turnaround. We will deploy the profits to shareholders, and checkmate the market. Will the market buy it?
Valuation Math
DB projects €30Bn revenue in 2024 (~5% YoY growth) while maintaining €20Bn operating expense, at a 67% CIR (Cost income ratio). €1.5Bn provision (30bps on €500Bn loan book), €1Bn one-off expense (e.g. FDIC surcharges, bank levies, restructure charge), $2Bn tax. It gets to €7.5B EBT and €5.5Bn net income.
At $15/share, 2Bn shares, $30Bn market cap, Deutsche Bank trades at ~3.7x NTM P/EBT, 5x NTM P/E
It plans to distribute 50% of net income to shareholders (already announced €0.45/share, a total of 0.9Bn div in 2024). That leaves up to ~1.6€Bn for the buyback (currently €0.675Bn approved). If its stock price remains unchanged, DB can buy back 5% of its equities at a 55% discount to TBV (~$34/share) in 2024.
Is it too good to be true? Can the mgt deliver such a lofty promise?
One obvious supporting argument is to examine how its last 4Y delivered (exceeded in a few areas) its 2019 turnaround plan. And then I came across this during a recent Q&A session.
Kian Abouhossein: And then secondly, just coming back to cost, clearly the target is adjusted cost €5 billion, about €5 billion, and just if you can talk a little bit about the levers that you have in case you will not be able to get to about €5 billion and what €5 billion about actually mean, is plus or minus 4%, 5%, how should we think about that?
James von Moltke (CFO): And then lastly on expenses, to give you a sense of what we would think is significant – is a range of outcomes, 1% rather than 4% is that we have the discipline, and for us missing by 1% or €50 million would be a disappointment. And that gives you a sense of how we’re managing the place.
It is unusual for a CFO to make a forward-looking statement with such precision. If one has followed Mr. Moltke for a while, as I do, he is often measured in his response. That increased my comfort level with its profit model.
Also, a quick look at its European peers’ Cost income ratio: both BNP and Barclays CIR are in the low 60s, and HSBC sports a 50% CIR, dropped from 70% just 2 years ago. (my modeled €20Bn OpEx, €30Bn Revenue gets to 67% CIR for Deutsche Bank, which would put DB in the middle of its peers)
Risks and Concerns
1. US CRE
When we talk about banking risks, we can’t avoid CRE nowadays. So let us get to it.
Out of its €480Bn loan book, €38Bn (~6.5%) are CRE loans, 31Bn in the scope of severe stress test (€7Bn lower risk e.g. data centers), and 17Bn is US CRE. if we apply 4.5% (reserve ratio for refinancing CRE loans over the last 5 quarters) to its entire US CRE loan, it would be €0.77Bn, If we apply 2% to the remaining €14Bn (non-US CRE), that will get to a total of €1.1Bn CRE reserve.
That’s a fairly punishing model, yet €1.1Bn is roughly DB’s one-quarter earnings.
Therefore, even if US (or global) CRE gets materially worse, it is a negative impact on net income event, not a stressed regulatory capital event.
2. Is DB the punchbag when next Crisis arrives?
This is a tough risk to argue against.
During the Credit Suisse (in Europe) and First Republic / Silicon Valley Bank (in the US) crises in 1Q23, DB’s stock lost 25% (from $12/share to $9/share) in 3 weeks.
Its 5Y CDS (credit default swap) went from 85bps to above 200 bps, and its AT1 bond moved sharply down.
Confidence is the KING in banking. When a crisis arrives, people sell first and then ask questions. If one isn’t mentally prepared for that, banking investment might not be a good fit.
Large banks (DB included) are in overall healthy condition. The chart below shows a group of large global banks with CET1 ratio ranging from 12% to 16.1%, about 100-200bps (on avg) higher than smaller regional/local banks (assets $5Bn - $500Bn), not to mention large banks adhere to stricter standard.
It is also worth noting some confidence-building evidence: multiple rating agencies’ upgrades (Fitch’s upgrade to A- on July 23, and S&P’s upgrade to A on Dec 23), and Deutsche Bank went through a few major events (including some closer to DB’s home, e.g. Credit Suidwss Collapse, Wirecard scandal) unscratched.
Reading Material
The battle plans of Hilmar Kopper, Jan 1994
Hilmar Kopper became the Board Chairman in 1989 when young Sewing joined DB. Kopper remained in the position till 1998 and left a long-lasting impact on Sewing.
I found this 1994 interview with Hilmar Kopper, my favorite piece during the research. The entire interview is worth reading, he talked about Deutsche Bank’s roots below.
Interviewer: Are you a retail or corprate?
Hilmar Kopper: If I am talking to a German, I stress retail, because he understands it better. Internationally, we prefer to be regarded as a corporate bank.
Q: What will you avoid?
A: Becoming a European retail bank, something that Credit Lyonnais is closer to than we want to be. We are a European corporate bank, in the best traditions of a universal bank; active in guilders in Amsterdam, French Francs in Paris, and sterling in London. This is what we are building.
Q: Why don’t you want to be a retail bank?
A: Because I look around in the world today and I can’t identify a country where I wish to be a retail banker.