Deutsche Bank Stock: A Deep Value Play Worth Considering (Rating Upgrade) (NYSE:DB)

Deutsche Bank Aktiengesellschaft (NYSE:DB) presents an exciting topic. Germany’s largest lender released its second-quarter earnings results in July. Furthermore, it is in the midst of litigation and faces declining Euroregion interest rates. Moreover, Deutsche Bank possesses grossly undervalued price ratios, yet some have questioned its fundamental performance.

Given the above, we considered revisiting our outlook on Deutsche Bank stock. We last covered the asset in March 2023, assigning a hold/market-neutral rating; herewith is our updated outlook.

Recent Performance

Deutsche Bank’s share price has increased by north of 30% year-over-year. However, a reversion of more than 10% has occurred in the past month, suggesting investors didn’t take well to its earnings report, released on July 24th.

Deutsche Bank’s recent price activity has dragged its stock below its 10-, 50-, 100-, and 200-day moving averages, placing its RSI at around 36. The asset’s latest price activity conveys a potential “buy-the-dip” opportunity. However, an assessment of its fundamental metrics is required before drawing any conclusions.

Q2 Results Review

Headline

Deutsche’s second-quarter earnings release communicated a mixed bag of results. The company’s reported revenue increased by 2.4% year-over-year to €7.59 billion, showing advances in gross earnings. However, Deutsche’s net earnings decreased to €411 million from €1.4 billion a year earlier. Moreover, as discussed later, the company recognized a €1.7 billion litigation provision, sending it into an accounting loss for the quarter.

The following diagram shows Deutsche’s profit and loss statement; a discussion follows.

Corporate Banking

Firstly, Deutsche’s corporate banking segment’s net revenue settled at €1.9 billion, with net interest income (NII), reaching €1.3 billion. NII slipped by 2% year-over-year, likely due to a tighter spread between funding and lending rates. Despite Deustche’s downturn in NII, its commission and fees-based revenue increased by 9% to € 624 million through higher trade finance and lending. Furthermore, Deutsche experienced an 8% increase in institutional client revenue to €532 million, a 2% decrease in Corporate Treasury Services revenues to € 1.1 billion, and a 9% decline in business banking to €332 million.

Where to from here?

Starting with NII, Eurozone interest rates have ticked down by 25 basis points since Deutsche’s last operating quarter, and CDS spreads are very tight. We believe lower real economic growth and declines in interest rates will spike credit spreads. Although enhanced credit risk and lower funding rates must be considered, we think Deutsche will pull back on loan originations (to manage risk) and secure lower spreads between its gross and net income.

Despite the above, corporate refinancings may increase a low-rate/high-credit-risk environment. Consequently, we anticipate Deutsche’s current trend of decreased NII with increased fee-based revenue continuing in late 2024.

Investment Banking

Deutsche’s Investment Banking Division’s (IBD) market share grew by 70 basis points in Q2, placing it in seventh place globally. During its second quarter, the segment experienced welcoming momentum from its fixed income and currency (FICC) leg, which grew by 3%, while financing grew by 7%.

We see plenty of opportunities in the investment banking space. Although global transaction volumes have slowed, the nominal M&A value has surged by 11.7% since the turn of the year, reaching $1.22 trillion. The M&A business’ value-based momentum might resume into late 2024 and throughout 2025 amid global interest rate pivots and a slowing economy. Why would these factors contribute to M&A? We think lower rates provide refinancing opportunities and broader access to capital. Moreover, a slowing economy introduces possibilities for distressed asset deal flow.

Furthermore, Deutsche’s FIC business is well-positioned. Global bond yields and currency pairs are exceptionally volatile, meaning cash management opportunities are in the offing. Whether Deutsche will tap into those opportunities remain to be seen.

Private Banking and Wealth Management

I included private banking and asset management in one section because we think the two businesses are long-term-oriented and less cyclical than Deutsche’s other segments. We see tremendous growth prospects in Deustche’s private banking unit, which has €34bn in assets under management. An emphasis on ancillary technology, such as the bank’s Postbank mobile application, provides wider access to depositors. Moreover, an emphasis on high credit score clientele allows throughout-the-cycle access to capital and lower default risk.

Lastly, Deutsche’s wealth management segment has about €933 billion in AUM, an increase of €37 billion during Q2, mainly driven by passive strategies. Given the momentum of global financial assets, we think sustainable growth in AUM is likely.

Costs and Provisions (Including Litigation)

Deutsche’s overall operating expenses grew during Q2. Most notably, the bank’s selling, general, and administration costs surged by 41% to €3.738 billion. Additionally, Deutsche Bank recognized a €1.4 litigation provision and suffered from a €75 million increase in loan loss provisions.

We think the bank’s SG&A will taper in late 2024 and early 2025 through Deutsche’s cost-cutting program, which includes mass layoffs. It is estimated that Deutsche will reduce its operating costs by €2.5 billion by 2025 year-end. We find the figure believable, given the company’s recent layoffs and a softer overall labor market.

Despite optimism about layoff costs, we think Deutsche’s credit loss provisions line item might suffer. As mentioned before, the Eurozone and global economy face headwinds, and a concurrent global interest rate pivot might spike credit risk, leading to higher credit spreads and probabilities of default. In addition, decelerating inflation might reduce collateral valuations.

Lastly, Deutsche Bank suffered a €1.4 litigation provision during Q2. The provision relates to its Postbank acquisition. To our understanding, Deutsche acquired full control of Postbank in 2010 for €25 a share. However, previous stakeholders argue that Deutsche gained influential control of Postbank prior to its outright acquisition. It’s believed that Deutsche gained control at about €57.25 per share, which has prompted previous stakeholders to seek a financial settlement.

According to Citigroup’s (C) Andrew Coombs, the provision spans about 2% of Deutsche Bank’s tangible book value, suggesting a realized charge is manageable. Additionally, we think a realized charge will result in a non-core cost and that Deustche’s recent decline in market value has accounted for any possibility of a realized charge.

Risk Metrics

A glance at Deutsche’s key risk metrics communicates numerous talking points. The bank’s key metrics are combined in the table below; a discussion follows.

Metric	Value
Liquidity Coverage Ratio	136%
Net Stable Funding Ratio	122%
CET 1	13.5%

Click to enlarge

Source: Deutsche Bank

The Liquidity Coverage Ratio measures a bank’s liquid assets versus short-term cash flow requirements. To our knowledge, LCR is a 90-day-based metric. However, its criteria may differ among banks. Nevertheless, Deutsche’s LCR is above 100%, suggesting adequate short-term liquidity.

Another metric worth considering is the Net Stable Funding Ratio. The ratio has characteristics similar to the LCR but usually assumes a one-year vantage point instead of emphasizing immediate liquidity. Like its LCR, Deutsche’s NSFR is above 100%, implying that it isn’t a solvency risk.

Now, for the metric that most market participants emphasize, CET 1. The common equity tier-one ratio weighs a bank’s equity capital against numerous segmental risk factors such as market risk, operational risk, and more. Deustche’s CET 1 remains above its targeted 13%, and the regulatory requirement of 4.5%.

Considering these results, we think Deutsche will maintain or enhance its risk exposure in late 2024 and/or 2025, providing latitude for higher gross returns. Sure, the bank’s restructuring means it has paused shareholder compensation. Nevertheless, assuming its risk ratios hold strong, a sharp increase in buybacks and dividends post-restructuring (ending in 2025) is possible.

Valuation

Continuous Residual Income Model

We used a continuous residual income model to value Deutsche Bank’s stock. The model emphasizes book value, which is ideal for a banking stock. Moreover, the RI model incorporates an equity risk premium, allowing for a holistic analysis. Although merely an indicator, the RI model provides valuable guideposts.

According to our model, Deustche’s stock has a fair value of around $31.74. Again, I reiterate that the RI model is an indicator; it doesn’t have a perfect hit rate.

Herewith are the model’s inputs.

1. Deutsche Bank’s Q2 tangible book value per share of €28.65 was converted at a EUR/USD market rate to set a baseline book value per share.
2. Seeking Alpha’s database was used to obtain Deutsche Bank’s projected EPS. The final year’s values were normalized.
3. Deutsche has suspended its dividend program until its restructuring is complete.
4. Alpha Spread was utilized to set Deutsche Bank’s CAPM, aka ordinary share discount rate.

Peer Analysis

We moved into a peer-based analysis as Deutsche’s price target seemed high. However, a comparison of its price-to-book (P/B) value with HSBC (HSBC), Barclays (BCS), Citigroup (C), UBS (UBS), and BNP Paribas (OTCQX:BNPQF) ranks best-in-class. Unlike its peers, Deutsche is restructuring, which has likely influenced its P/B. Nonetheless, we think factors like the bank’s positive core earnings, compelling risk metrics, and restructuring plan present a deep value opportunity.

Stock	P/B
UBS	1.08x
HSBC	0.92x
BNP Paribas	0.62x
Citigroup	0.58x
Barclays	0.57x

Click to enlarge

Source: Seeking Alpha

Here’s a diagram showing the disparity between Deutsche’s total return and those of its peers. The stock has underperformed its peers in the past three months but maintains its year-to-date outperformance. Does this present a pairs trade opportunity? We think so.

Lastly, a view of Deutsche’s income-based prospects. As previously mentioned, the bank recently scrapped its dividend. Although it might discourage income-seeking investors, we think the suspended dividend provides substance to a succinct restructuring. Moreover, a dividend usually detracts from a company’s book value. Therefore, strengthening the argument for a deep value opportunity.

Limitations Of The Analysis

Our analysis of Deutsche Bank possesses a few limitations.

Firstly, we made hard-line assumptions about the Eurozone’s interest rates and risk premiums. The bond market is dynamic, and therefore, forecasting risk premiums always holds a degree of uncertainty.

Furthermore, most of our talking points were systematically assessed. Gaining a granular understanding of a bank is challenging. Thus, we encourage investors to look at Deutsche’s idiosyncrasies.

Another risk factor worth considering relates to FX translation. We used a market rate to translate Deustche’s Euro earnings to U.S. dollars. Methodologically, such assumptions introduce a margin of error.

Conclusion

We think Deutsche Bank provides a deep value opportunity. The stock has declined month-over-month after Deutsche announced litigation challenges and ongoing restructurings. However, we think interim support from Deutsche’s investment banking unit, paired with long-term growth in its private banking and wealth management divisions, provide tailwinds. Furthermore, our residual income model deems the stock grossly undervalued.

Deutsche’s stock likely presents an excellent entry point to investors.