The Decline In Deutsche Bank’s Stock Makes Sense, But Looks Overdone

by Trefis Team
Deutsche Bank
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Deutsche Bank (NYSE:DB) saw its shares tank nearly 5% over trading on Thursday, May 24, after it revealed plans to slash more than 7,000 jobs in its Corporate & Investment Banking division by implementing significant cuts to its global equity trading business. The announcement adds some clarity to the large-scale reorganization plan the German banking giant unveiled late last month, which was rather vague on details. In the recent announcement, Deutsche Bank set itself an adjusted cost target of €22 billion for 2019 and aims to achieve a return on tangible equity (RoTE) of 10% by 2021.

So why did the announcement trigger a sell-off in Deutsche Bank’s shares? We believe there were several factors at play here:

  • The latest reorganization is the fourth one announced by the bank in three years. Investor skepticism in the plan, and (more importantly) in Deutsche Bank’s ability to see it through is likely the biggest factor
  • The sizable cuts in its equities business makes Deutsche Bank’s results in the future more dependent on the performance of its FICC trading desk. This is less than desirable, given that its FICC trading operations are generally more volatile and also more capital intensive compared to equity trading. Notably, this is the opposite of what global banking giants Morgan Stanley and UBS did to successfully restructure their business model after the economic downturn
  • While most of Deutsche Bank’s peers in the U.S. and Europe turned around their businesses years ago, things are unlikely to settle down for the German bank until at least 2021 by its own admission. Investors seem to be running out of patience with the bank

Despite the overall uncertainty around Deutsche Bank’s ability to successfully follow through with the latest reorganization plan, we believe that the new plan makes sense in the long run. As we detail in our interactive dashboard for the bank, the new reorganization plan trades off some long-term value for stability, and believe that the fair value for Deutsche Bank’s stock is closer to $16 – about 30% ahead of the current market price. The sell-off, hence, provides a great entry point for investors looking for long-term value.

Our conclusion is primarily based on the fact that Deutsche Bank’s new business model largely resembles those of HSBC and Citigroup, with the exception that Deutsche Bank’s retail and commercial banking efforts are geographically focused primarily in Europe as opposed to the significant geographical diversification for the other two banks. These banks have a strong presence in the global FICC trading industry, and have shrunk their equity trading desks since the downturn.

In our opinion, the key drivers of value for Deutsche Bank in the long run will be:

  • Increased Dependence On Stable Revenue Sources: Although Deutsche Bank’s investment banking division is likely to churn out more volatile revenue figures going forward due to its larger focus on FICC trading, it should be noted that the bank intends to reduce the contribution of investment banking revenues to its top line to just 35% from the current level of 50%. With the bank’s Private & Commercial Banking, Asset Management and Global Transaction Services segments expected to contribute nearly two-thirds of total revenues, Deutsche Bank’s business model will generate more stable return for investors in the future.

  • The FICC Trading Desk Is Only Playing To Its Strengths: Deutsche Bank’s decision to significantly cut down on the U.S. rates trading business while focusing on European clients makes sense, as the bank has had little luck competing with the U.S. investment banking giants on their home turf. Also, Deutsche Bank has steadily lost market share in global currency trading over recent years, and limiting its efforts to areas in which it remains dominant will help profit margins in the long run.

  • Prime Brokerage Industry As A Whole Has Been On A Decline : The prime brokerage business (which works with hedge funds) has been under pressure for years as the industry at large suffered from poor revenues. And the situation is not expected to improve in the near future. With many global investment banks already trimming down their prime brokerage operations over the years, Deutsche Bank’s move is a welcome one.

  • The Most Critical Aspect Of The Plan Is Cutting Costs: The key focus of Deutsche Bank’s restructuring efforts is to slash costs to below €23 billion this year and further to below €22 billion next year (on an adjusted basis). A bulk of this reduction will come from the ~8% reduction in headcount (from 97,000 now to less than 90,000), besides previously announced simplification to Deutsche Bank’s structure. Other improvements to operational efficiency should help margins across divisions going forward. The slight reduction in margins for the investment banking division for 2018 is due to increased restructuring and severance costs of €800 million associated with the new plan.

We expect Deutsche Bank’s adjusted EPS for full-year 2018 to be around EUR 1.20. Using this figure with our estimated P/E ratio of 11, this works out to a price estimate of $16 for Deutsche Bank’s shares (assuming a EUR-USD exchange rate of 1.2).

In case you disagree with any of our forecasts, feel free to modify them in our interactive model to come up with your own forecast for Deutsche Bank

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