Societe Generale Stock: Frustrating Wait Goes On To Be Rewarded (SCGLF)

I’ve been critical, sometimes sharply so, of Société Générale (OTCPK:SCGLF) over the years, as the company stumbled from one partially successful restructuring effort to another, but despite evidence of real progress at this large French bank, the market just doesn’t care. The shares have fallen almost by half since my last write-up, despite better-than-average performance in core banking and capital markets operations.

Progress is a relative term, though, and this is still a bank that will be earning single-digit returns on tangible equity for at least a few more years, and as U.S. investors have seen with Citigroup (C), the market is not particularly eager to reward under-earning banks with material reratings. The low level of expectations built into the valuation today suggests patient shareholders could be well rewarded down the line, but “how far down the line” is a very fair question to ask, and Societe Generale may yet struggle to establish itself as more than a trailing rival in the majority of its key markets.

French Retail Performing Better

After an extended period of lackluster performance, there has been better performance of late from SocGen’s French Retail operations – a business that still accounts for close to a third of revenue and close to a quarter of pre-provision profits.

Revenue rose more than 8% year over year and 3% quarter over quarter in the second quarter, though net income was still sluggish, falling 1% yoy and qoq. That revenue result was good for a 6% beat versus expectations, though, and SocGen’s net interest income was a fair bit better than that of BNP Paribas (OTCQX:BNPQY) in the French operations, with 5% year-over-year loan growth.

Coupled with better expense control, pre-provision profits rose 17% yoy and 59% qoq in the French retail operations, considerably better than the -6% yoy/up 39% qoq performance of BNP, and good for a roughly 20% beat versus sell-side expectations.

SocGen’s internet bank Boursarama continues to be a strong driver. Customer count increased about 35% from the prior-year period, and would have still been up strongly excluding customers gained through a transition agreement with ING Groep (ING). Loans in the business grew 28%, and the operation is also seeing strong deposit growth.

Maintaining this growth is a key challenge for management. The French retail banking market is not really seen as an attractive growth market, but Boursarama’s results would suggest that there are opportunities to grow with a differentiated service offering. The bank is still in the process of merging its traditional branch-based operations and strong execution here – particularly where it concerns minimizing customer attrition while achieving significant cost savings – is vital.

Better Results, Relatively Speaking, From Global Markets

SocGen was not immune to the capital market pressures that hit the fixed income and equity trading markets in Q2, as both fixed income (down 11%) and equities (down 18%) saw double-digit sequential declines. Still, the business is generating significantly better profits (pre-provision profits up 82% year over year, and over 37% of revenue after generating 18%-plus margin in Q1’22) after management’s restructuring efforts and it looks as though SocGen gained a little bit of share in trading.

Holding on to this enhanced profitability is another vital element to SocGen’s turnaround plan. The company’s ongoing focus on higher-returning business should help that process, but I also see some possibility of gaining profitable share. SocGen has already undergone a difficult restructuring process, but many of its large U.S.-based rivals may look to reduce their capital allocations in these areas to help build capital (in accordance with Fed requirements). As these players reduce their exposures, that could be an opportunity for SocGen to selectively fill in and gain some share.

Entering The Next Phase Of A Seemingly Endless Turnaround

A few months ago, CEO Frederic Oudea announced that he would be stepping down from the CEO role at the end of his term in May 2023. Oudea’s tenure has been controversial, and he’s received a lot of criticism from analysts for SocGen’s perceived lack of progress, but if you look at the performance of SocGen compared to other large European peer banks, the 65% share price decline is still better than the performance of ING, BBVA (BBVA), and Santander (SAN), and only slightly worse than that of the STOXX 600 bank index (BNP and Credit Agricole (OTCPK:CRARY) have both done better).

Oudea leaves SocGen in arguably the best shape it’s been in since the global financial crisis and the rogue trading incident that lead to his appointment as CEO. The Global Markets business has been meaningfully restructured, the company merged ALD and LeasePlan to create a major force in the profitable auto leasing market, the bank exited Russia, and the restructuring of the French retail operations are underway.

There’s still work to do – the French retail operation merger has to be handled well, and managing Boursarama’s growth will be critical over the next few years. Additionally, it would probably serve the bank well to once again re-examine some of its international operations (like ING has been doing) with a realistic eye toward the growth and returns on capital that each unit can offer.

The bank has not yet named a successor for Oudea, but the company did offer new long-term guidance with second quarter guidance. This guidance includes a projection of 3% annualized revenue growth through 2025 and a 10% ROTE in 2025. Those should be attainable targets, but it’s been a while since SocGen has generated results close to that on a consistent basis and “should” is a dangerous word in investing. At a minimum, I would hope that the next CEO candidate is able to deliver a reasonably detailed plan on how the bank will achieve those targets, as today’s valuation clearly does not view them as likely to be achieved.

The Outlook

The prospect of higher rates in Europe is a welcome one for banks that have been struggling for years to build net interest margins. Still, there are plenty of macro operating risks, including the prospect of ongoing energy crises due to Russia’s war in Ukraine and weaker loan demand due to reduced business activity (and/or confidence).

My long-term core earnings estimates for SocGen haven’t changed that much, though the impact of the Russia exit and other near-term challenges do reduce my estimate for FY’22 more significantly. Over the long term, I’m only looking for around 2% to 3% core earnings growth, and I don’t expect the bank to achieve a double-digit ROE.

The Bottom Line

Between long-term discounted core earnings and a ROTE-driven P/TBV valuation approach (assuming a 7.2% ROTE in FY’23), I believe SocGen is materially undervalued. Unfortunately, the market just has no interest in a bank with a ROTE below its cost of capital and low long-term core earnings growth prospects. While patient investors may see the outsized potential returns as worthwhile, I wouldn’t ignore the risk of these shares continuing to be a long-term value trap, with core earnings growth and returns on capital that are just too low to generate enough interest among institutional investors to drive a meaningful rerating.