Banking stocks can be terrific investments. Recently a lack of credible growth options have also seen some banks return more cash to shareholders in the form of dividends great for those looking for income.
Banco Santander (LSE: BNC) (NYSE: SAN.US) is a noticeable absentee on this list. In fact, the bank has a most unusually shaped dividend distribution. Stay tuned to find out more about this and why Im concerned about its sustainability. First though, lets take a look at a big challenge facing Santander. Its a challenge thatI think the banks management would prefer British investors were blissfully unaware.
Dark clouds gather in Europe
The president of the European Central Bank (ECB), Mario Draghi, famously said the ECB would do whatever it takes to ensure the financial security of the euro zone and preserve the euro. Very basically speaking that involves a plan to underwrite the sovereign debt securities market. Now analysts speculated that this was a hollow promise because the ECB didnt have the firepower to follow-through on this policy. Despite that, markets have yet to really call his bluff.
The growing concern now though is that the ECB and governments in the region have been caught out by recent signs of a slowdown in France and Germany. The German Economy Ministry recently reduced the countrys 2014 growth forecast to 1.2%, from 1.8%. In addition, official Eurostat figures showed that industrial production across the euro zone slumped in August by 1.8%. Its now almost 2% lower than it was a year ago. Make no mistake the euro zone is flirting with yet another recession. Markets for which the banks are exposed are already getting a little fidgety.
So how exposed is Santander to the euro zone economy? Well, as a whole, the bank generates around 26% of its income from Continental Europe. Spain accounts for about 7% of the Groups profits. Recent concerns of economic deterioration in Germany (and elswhere) though have seen Greek bond yields push up to around 9%. If the euro wobble were currently experiencing continues, the banks European earnings may suffer.
Germany is a particularly important country to watch. Santander has more than 6 million customers in the country. Santander describes the banks division there as a consumer finance leader with an important retail banking business. The Spanish bank, according to its latest annual report, says it expects Germanys contribution to the Groups profits to rise in the coming years. That now looks less likely. This will be made more pronounced if the regions periphery countries find themselves in trouble again in the next few months.
A neat policy now looking a bit messy
A little side-track now to Santanders dividend policy but stay with me.
Companies sometimes give shareholders the option of not taking dividends in the form of cash, and instead taking more shares or scrip. In Santanders case, a bit less than 90% of shareholders choose the scrip option. Thats very unusual. Its also interesting that even just a quick glance at the companys earnings exposes the fact that the bank cant afford its current payout policy.
Attributable profit in 2010 was 0.94; in 2011 it fell to 0.60; then in 2012 it slipped further to 0.23. It rose in 2013 to 0.40. The dividend payout though remained at 0.60.
Even in 2014 the dividend was once again reaffirmed at 0.60, while earnings per share rose only slightly to 0.49.
Now thats not necessarily a problem for Santander because its not in effect paying out that much cash. It is, however, reliant on shareholders maintaining their current payout preferences. Its also dependent on the continuation of favourable economic trends which more and more commentators now question.
Some final Foolish thoughts
Still with me? Great! So all up I think management would prefer you didnt know that City analysts expect Santanders dividend to fall to 0.55 (0.43) next financial year (down over 3%). Thats not really surprising considering what we know from above (the banks policy seems unsustainable). In addition, earnings, previously expected to rise slightly, are now in question due to the banks international exposures.
A lot rests on the property markets of both Britain and Spain, as well as general economic growth in Europe.
It’s always very difficult to predict or forecast the future. A better idea is to work on being as strong as you can be now, so any curve balls that get thrown your way down the track are easier to deal with. This works for banks too.
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David Taylor has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.