A fresh breath of life for Europe's banks

The European banks that shareholders deserted in droves two years ago are starting to look more attractive to value investors.

As sovereign risk slowly abates, investors are looking at European equities once again, especially as valuation metrics suggest they are rich for pickings. Financials specifically are in focus as the sector looks cheap on all fronts and is certainly cheaper than the Australian equivalent.

Europe in general is back on the radar for many investors and Macquarie has gone as far to tip a 15 per cent total return for next calendar year. 

While Europe still has many structural and political problems to overcome low inflation is supporting the spluttering recovery, and there is little threat of this changing. Consequently we can expect monetary conditions to remand accommodative as the region continues along its recovery path, supporting financials along the way.

Peter Wilmshurst from Franklin Templeton explained the investment group has been overweight Europe for many years in some funds, but the composition has changed in the last eighteen months or so. The change saw a greater tilt to financials, with the investment manager selling existing investments in companies such as Unilever which didn’t offer such compelling value fundamentals.

After reaching a low in November of 2011 when Greek default concerns were at a peak, European financials (white line) have outperformed their Australian equivalents (green line) by 5 per cent. The performance of the sector is comparable to Australian banks, which continue to be in much better health.

Graph for A fresh breath of life for Europe's banks

Much focus on European financials has centred around reasons not to invest in the sector – sovereign risks that have plagued the region and balance sheets that were in absolute disarray. But as shareholders fled financials in the masses it left some banks looking extremely cheap on a valuation basis, getting investors with a value tilt excited.

A valuation measure of banks, price to book has been estimated to be around 0.94 times by Credit Suisse – concluding the sector is cheap by historical standards. Domestically price to book ratios span for 1.8 times from ANZ Bank and go as high as 2.5 times for the Commonwealth Bank, making European banks look really, really cheap.

It goes without saying the uncertainty engulfing the region is partly commensurate with European banks trading at a discount.

Ignoring valuation metrics alone, banks are well placed to climb higher as the economic conditions in Europe continue to improve. Macquarie expects GDP in Europe to come in around 1.2 per cent in the year ahead. If the historical relationship of European financials moving in tandem with economic momentum holds, the future for European financials could see share prices move closer to their intrinsic value.