20000112Consolidation still a driver for Euro bank stocks

LONDON: The European bank sector, fresh from a year of high activity in mergers but share price underperformance, looks set to plough a similar furrow in 2000.

Merger and acquisition action is expected to continue this year but the sector is unlikely to gain much solace from improved operational conditions. Rising short-term interest rates but little change at the longer end of the yield curve over the year are also unlikely to benefit the banking sector.

Analysts expect M&A deals to have a more pronounced cross-border content than hitherto but remain unconvinced that this will a boost for share prices.

"It is difficult for us to see how such a activity would be perceived as a material positive for the sector as a whole," said Morgan Stanley Dean Witter banking analyst Alan Broughton, "given the relative lack of earnings and strategic benefits that we believe would accrue to shareholders from such a trend."

Analysts also expect the strategic impact of the Internet to grow quickly, although there is disagreement on how deep the impact of the Web will be on the established banking players.

One effect the Internet could have is to make the normal logic of consolidation - cost saving - less appealing.

"One result of the rise of the Internet is that consolidation looks less necessary if you can cut costs or expand via direct means," said Bryan Crossley, European banking analyst at ABN AMRO. "Consolidation is looking, at best, a zero sum game."

On an operational basis, the Internet is likely to increase downward pressure on margins and, at least in the short to medium term, produce upward pressure on costs as banks invest.

However, the Lehman Brothers European banking team comes to the conclusion in a research note that Internet fears are overdone.

"Internet distribution should not lead to a collapse in banking profitability," Lehman says. "We believe that the market will continue to be dominated by the existing players, who will just distribute their product differently, and at lower cost.

The note adds that the real winners in the process will be those that can use direct distribution to boost market share.

Stock picks among the securities houses vary quite widely for 2000 although a few banks including Spain's BSCH and BNP Paribas of France get more than one mention.

BSCH is Merrill Lynch's top banking stock for 2000 with analyst Richard Coleman citing an "excellent" domestic business picture, improving margins and volumes growing by eight percent.

He said the bank, also chosen by ABN's Crossley, will also benefit from cost savings which are still likely to surprise on the upside and from improving conditions in its Latin American business and is "very well placed in the cross-border race, with strong links to Italy, Germany France, Portugal and the UK".

Other European banks favoured by Merrill for 2000 are: Unicredito Italiano, a consolidation beneficiary; Britain's HSBC, a play on global growth; and Lloyds, "a company seemingly primed to extend its reach outside of the UK."

Lehman is also a buyer of Lloyds TSB which stands on a 2000 PE multiple of only 12.2. Among the other British banks Lehman also favours Barclays.

Another supporter of Barclays is Warburg Dillon Read which includes the British bank in its Top 30 Focus List and says that it is trading at an unjustified discount to both the British and European banking sectors.

Warburg also supports BNP Paribas with a "strong buy" recommendation, seeing positives from the French economic environment, volume growth, reducing margin pressures and further cost control.

Goldman Sachs also includes BNP Paribas in its recommended list and has an end-2000 price target of 117 euros for the stock which currently trades at just above 85 euros.

Its other European bank pick is Deutsche which is seen at a compelling valuation of around 16.7 times estimated 2000 earnings with its underlying bank business at a 2000 PE of 11.6 - a 21 percent discount to the European banking sector.

Among Swiss banks, both the majors get some support with Warburg going for Credit Suisse and Lehman for UBS while in Scandinavia, MeritaNordbanken is on Lehman's "buy" list while Swedbank is favoured by ABN AMRO.

In Italy, Merrill picks Unicredito as a consolidation beneficiary while Warburg chooses SanPaolo IMI for its focus list, hoping for a re-investment of excess capital in retail banking acquisitions in northern Italy.

Hot favourites to see merger action in the sector are Credit Credit Commercial de France, already the subject of a bungled approach by one of its major shareholders ING of the Netherlands, and the German Banks.

Many believe the smoke surrounding a merger between Dresdner Bank and HypoVereinsbank will lead to a fire eventually, while the German government's unexpected tax proposals have boosted the bank sector with extra resources, although some analysts are not confident that these can be usefully deployed to create value given the track record.-Reuters