Strategic Trade / Buy
Head of Equity Strategy
Summary: Shares of Danske Bank have fallen by 44% since early 2018 on the firm's Estonian money laundering scandal, but Denmark's largest bank retains solid fundamentals.
Price Target: DKK 207.50
Market Price: 129.50
Danske Bank’s money laundering scandal, which came to light in early 2018 and related to issues at the bank’s Estonian branch in the years 2007-2015, has lowered the share price by 44% since it surfaced. The scandal is the biggest in Europe’s history and an embarrassment for Denmark as the country prides itself as a transparent country with high ethical standards. Shareholders are deeply concerned over the revelations and management's slow reaction to the scale and consequences of the scandal.
The Estonian branch’s non-resident business profited around DKK 1.7bn in the period 2007-2015; this implies penalties in the US of up to around $1 billion according to estimates provided by Bloomberg. Danske is being investigated by the US Securities and Exchange Commission, the Department of Justice and the Treasury Department, with the latter likely posing the biggest risk to Danske Bank.
We also see a small probability of Danske Bank being cut off from the US financial system like Latvian bank ABLV was in 2018, though Danske Bank is cooperating with US authorities.
The Financial Times reported back in January that consensus is looking for an aggregate fine of around $5bn while the Bloomberg Intelligence team covering banks put the estimate around $2bn. Both amounts can be dealt with by Danske Bank, particularly as the fines will drag out over years, diluting the impact.
From an ongoing concern perspective, the fines are one-off items with some potential effect on the bank's continuing operations (likely a small impact due to the stickiness of banking business), so the impact on return on equity should be limited.
Entry: Limit buy in the DKK 120-140 range
Stop: DKK 100
Target: DKK 207.50
Time Horizon: Until June 30, 2020
Danske's money laundering scandal obviously carries the risk that client relationships will be lost, impacting the business negatively. Danske Bank also derives around 52% of its net revenues from Denmark, making the bank dependent on a strong economic outlook for the country.
So far, Denmark’s macro numbers have outperformed those of other European countries despite the global slowdown. But should we experience a steeper slowdown that impacts Denmark as well, it would most likely increase loan impairments and lower return on equity. Should interest rates continue to go lower or just stay at current levels, it will act as an upper ceiling on return on equity. For shareholders there is also the risk of dividend cuts but currently sell-side analysts are still modelling a payout ratio of 50% of earnings despite the outlook and potential fines.
The biggest risk to our target price is our assumption that Danske Bank can maintain a 10% return on equity. We are basing our assumption on the guidance from the bank, sell-side analysts' assumptions and recent history, coupled with the bank’s market position. Should the return on equity drop to around 6% due to macroeconomic reasons and business impact from the money laundering scandal, though, the fair price drops to DKK 157.60 – around 21% higher than the current market price.
Given the historical relationship, the return on equity could drop to as low as 4% given the current price-to-book ratio. It our opinion the share price leaves a significant margin of safety, but clearly our return on equity assumptions are critical to the fair price estimation.