BES' share price is down ~11.7% in the past 5 days, which we believe
reflects management/corporate governance changes as well as investor
concerns around the asset quality in Angola. However, in our view nothing
has financially changed since we published our "Banco Espirito Santo:
Earnings recovery potential and a macro play on Portugal - upgrade to
Neutral" note in May. In our view the management changes are positive and
we believe the risks in Angola are manageable. Trading at 0.5x PNAV and
9.0x P/E for a 6% RoNAV in 2016e plus ~102% EPS upside risk in our blue
sky scenario, we believe this could provide an opportunity to pick up BES
shares). However, whilst we view BES as a good macro play on the
Portuguese macro recovery combined with emerging markets growth, we
recognize uncertainty around the asset quality of the Angolan loan book
(€6.1bn) and reputational risk arising from the financial irregularities at
Espirito Santo International (indirectly owns ~12% of BES), who share some
of the same board of directors. On the back of this we reiterate our
Neutral rating.
A brief summary of recent events:
* New ownership structure - post the €1bn capital increase ESFG holds
25% (~27% pre-rights) and Credit Agricole ~15% (~20% pre-rights) in
BES. Both companies are subject to a 6 month lock-up period post the
rights issue. In our view the reduced holding by ESFG/Espirito Santo
family is positive.
* New management - given the change in ownership ESFG proposed 20
June 2014 that BES CFO Amílcar Morais Pires replace Ricardo Salgado as
Group CEO. Additionally 5 board members (all part of the Espirito Santo
family) have resigned from the Board and ESFG proposed to appoint Paulo
da Mota Pinto, as Chairman of the Board replacing Alberto de Oliveira
Pinto. A General Meeting will be held on 31 July 2014 after which Bank of
Portugal has said it will evaluate the new Board members that are elected.
In our view increased independence from the Espirito Santo family is again
positive.
* Not new - reputational risk from ESI - material irregularities were found
in the accounts of ESI (disclosed in the rights issue prospectus), which
indirectly owns ~12% in BES and is a private company (ie no public
financials available). Whilst BES has no direct credit exposure to ESI and
is not responsible for the Holding Co's accounts, it could affect BES'
reputation. ESI has €823mm of bonds outstanding (as of 27 May 2014),
which are unconditionally and irrevocably guaranteed by ESFG (with
~€700mm of provisions against it) and have been subscribed by BES'
clients. Given the accounting irregularities at the ultimate Holding Co, we
view reduced influence from the Espirito Santo family as positive.
* Angola - question marks around the asset quality. With ~€4.2bn of
loans (total credit of ~€6.1bn in Angola) covered by an 18mths sovereign
guarantee, there are some question marks around asset quality, especially
once the guarantee expires. BES doesn't recognize any NPLs on the
guaranteed part of the loan book, while has ~€33mm of NPLs
corresponding to a ~2% NPL ratio against €246mm of provisions (745%
coverage) in the non-guaranteed part of the book. This compares to a
~6.2% NPL ratio (>90d overdue) and ~63% coverage of the entire Angolan
loan book in 2012. Assuming the Angolan NPL ratio has remained
unchanged yoy, would imply NPLs of ~€342mm on the non-gteed book
and ~72% coverage on the entire book, which in our view is manageable.
With a ~20% market share in Angola, BES is arguing that the guarantee
reflects its systemic importance in the country.
* Espirito Santo de Investimento, a subsidiary 100% owned by BES and
run by Ricciardi, who is member of the Espirito Santo family and who
resigned from the Board on 24 Jun 2014. Mr Ricciardi's stated ambition is
to develop the investment banking business further and dilute the
ownership. Whilst he has been quoted in the press saying the investment
bank "plans significant capital increase" (Bloomberg 20 Jun 2014) we
would note that this reflects his growth ambitions for the subsidiary and
not any capital shortfall. Hence, in our view this is manageable.
