Legacy IT And Demographic Shifts Will Undermine European Banking

Key Takeaways

• Rapid digital disruption, regulatory pressures, and legacy inefficiencies threaten Sabadell's market share, margin levels, and ability to effectively compete with technology-driven entrants.
  
• Domestic market concentration and demographic headwinds limit growth potential, exposing Sabadell to increased earnings volatility and operational risks.
  
• Expanding revenues, improved efficiency, stronger asset quality, robust capital, and enhanced shareholder returns position the bank for sustained profit growth and resilience.

Catalysts

Provides banking products and services to personal, business, and private customers in Spain and internationally.

• Despite the current acceleration in loan volumes and strong asset quality metrics, Banco de Sabadell faces a growing threat from accelerated digital disruption by fintech startups and global tech companies, which is likely to erode traditional banking market share over the coming years, ultimately placing downward pressure on future revenues and compressing fee income as more customers migrate to agile, technology-led competitors.
  
• The demographic aging trend throughout Spain and Europe is poised to result in a persistent slowdown in loan demand and overall credit growth, which, despite recent gains, will likely cap Sabadell's ability to expand its loan book and limit sustainable revenue and net interest income growth in the long run.
  
• The company's legacy IT infrastructure and ongoing operating inefficiencies, particularly when compared to digital-native rivals, risk undermining cost containment efforts and perpetuating a structurally higher cost-to-income ratio, which could manifest as margin compression and reduced operational leverage despite ongoing branch network optimization efforts.
  
• As Sabadell further concentrates its operations within Spain following the agreed sale of TSB, it faces heightened exposure to a highly competitive, low-growth domestic market, increasing its vulnerability to localized economic downturns and raising the risk of revenue and earnings volatility in future periods.
  
• Heightened and evolving regulatory expectations-especially around ESG, open banking, and compliance with new EU banking directives-are expected to significantly increase operational complexity and costs for Sabadell, reducing capital flexibility and negatively impacting net margins and long-term earnings outlook as compliance expenses mount.

Banco de Sabadell Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Banco de Sabadell compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Banco de Sabadell's revenue will decrease by 5.4% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 31.8% today to 29.9% in 3 years time.
• The bearish analysts expect earnings to reach €1.5 billion (and earnings per share of €0.3) by about August 2028, down from €1.9 billion today. The analysts are largely in agreement about this estimate.
• 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 10.2x on those 2028 earnings, up from 9.5x today. This future PE is greater than the current PE for the GB Banks industry at 9.9x.
• Analysts expect the number of shares outstanding to decline by 1.36% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.38%, as per the Simply Wall St company report.

Banco de Sabadell Future Earnings Per Share Growth

Risks

• Sustained growth in performing loans, customer funds, and off-balance sheet products in Spain, combined with robust loan origination across mortgages, consumer loans, and SME financing, indicates an expanding revenue base that could support long-term increases in revenues and earnings.
  
• Effective cost management programs, as evidenced by disciplined cost control and a decline in total costs ex-TSB quarter-on-quarter, point to improved operating efficiency, which may bolster profit margins and overall earnings over the long run.
  
• Significant improvement in asset quality, including a lower nonperforming loan ratio, higher coverage ratios, and declining stock of foreclosed assets and NPAs, reduces credit risk and provision expenses, enhancing net profit potential.
  
• Strong capital generation, a rising fully loaded common equity Tier 1 ratio, and a substantial management buffer position the bank well for regulatory compliance and potential business expansion, supporting balance sheet resilience and future profitability.
  
• Enhanced shareholder returns through an increased dividend payout, boosted by proceeds from the TSB sale and recurring strong capital generation, may improve investor sentiment and drive higher share prices by supporting total shareholder return.

Valuation

• The assumed bearish price target for Banco de Sabadell is €2.33, which represents two standard deviations below the consensus price target of €3.16. This valuation is based on what can be assumed as the expectations of Banco de Sabadell'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 €4.0, and the most bearish reporting a price target of just €2.3.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be €5.1 billion, earnings will come to €1.5 billion, and it would be trading on a PE ratio of 10.2x, assuming you use a discount rate of 9.4%.
• Given the current share price of €3.44, the bearish analyst price target of €2.33 is 47.8% 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.