Digital Expansion And Regional Concentration Will Pressure Margins And Future Earnings

Catalysts

About Banco do Estado do Rio Grande do Sul

Banco do Estado do Rio Grande do Sul is a regional Brazilian bank that offers a diversified mix of retail, corporate, foreign exchange and payment services, with a strong presence in Rio Grande do Sul.

What are the underlying business or industry changes driving this perspective?

• The accelerated push into digital channels, including hundreds of thousands of new app accounts and heavy reliance on automation, risks saturating its core regional customer base and exposing execution gaps in digital onboarding and risk analytics. This could slow revenue growth and increase credit losses, compressing future earnings.
• The integration and expansion of the Vero acquiring network into Banrisul's core business model heightens exposure to fierce pricing competition and regulated fee caps in payments. This may force lower merchant discount rates and service fees, eroding net margins even if transaction volumes rise.
• The strategic concentration in Rio Grande do Sul, including corporate, agribusiness and export related credit, leaves the bank vulnerable to local economic, climatic and political shocks. These could simultaneously pressure loan growth, elevate default levels and drive higher cost of risk, weighing on net income.
• The planned reacceleration of payroll and private payroll lending after system and biometric adjustments could coincide with a prolonged high interest rate environment and stricter regulatory constraints on tenors and pricing. This may limit spreads and raise delinquency risks, which would undermine profitability metrics such as ROAE.
• The growing reliance on prefixed funding and long dated subordinated instruments to balance assets and liabilities in anticipation of interest rate movements could backfire if rates remain elevated or become volatile. This could increase funding costs and mark to market pressures, with a direct negative impact on net interest income and earnings stability.

Assumptions

This narrative explores a more pessimistic perspective on Banco do Estado do Rio Grande do Sul compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Banco do Estado do Rio Grande do Sul's revenue will grow by 16.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 17.2% today to 9.9% in 3 years time.
• The bearish analysts expect earnings to reach R$1.2 billion (and earnings per share of R$2.8) by about December 2028, down from R$1.3 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as R$1.4 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 6.7x on those 2028 earnings, up from 4.8x today. This future PE is lower than the current PE for the BR Banks industry at 8.0x.
• The bearish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 20.28%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The continued acceleration of digital adoption, with 215,000 app accounts opened and close to 300,000 expected by November, together with over 80 AI powered robots improving productivity, may support sustained fee income growth and efficiency gains that bolster revenue and net margins in the long term.
• Management’s deliberate strategy to diversify beyond a single product, by integrating the Vero acquiring network, expanding foreign exchange services and deepening penetration into small and medium sized corporate clients in Rio Grande do Sul and Santa Catarina, could create multiple resilient revenue streams and support long term earnings growth.
• Disciplined credit underwriting, with a cost of risk at 1.4%, a largely collateralized individual portfolio of more than 70%, a focus on receivables backed lending and cautious appetite for unsecured credit, may preserve asset quality and limit credit losses, supporting stable or improving net margins and earnings over time.
• Strong funding dynamics, with 14.6% growth in funding, stable funding costs close to the Selic benchmark and proactive asset liability management that nearly neutralizes interest rate risk, may position the bank to benefit disproportionately from any future decline in interest rates, which would support net interest income and overall profitability.
• Ongoing cost discipline, with tightly controlled administrative expenses growing below inflation and headcount costs managed within collective bargaining constraints, combined with a Basel capital ratio of 17.9% strengthened by subordinated issuances, could sustain double digit ROAE and provide capacity for profitable growth, thereby supporting earnings resilience in the long run.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Banco do Estado do Rio Grande do Sul is R$11.0, which represents up to two standard deviations below the consensus price target of R$12.68. This valuation is based on what can be assumed as the expectations of Banco do Estado do Rio Grande do Sul's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of R$16.0, and the most bearish reporting a price target of just R$11.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be R$11.8 billion, earnings will come to R$1.2 billion, and it would be trading on a PE ratio of 6.7x, assuming you use a discount rate of 20.3%.
  
• Given the current share price of R$14.81, the analyst price target of R$11.0 is 34.6% lower.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.