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Morningstar | Santander Posts Decent 2018 Results, but Political Uncertainty Weighs on Valuation

Narrow-moat Santander reported underlying attributable profit of EUR 8.1 billion for fiscal 2018, which was 7% ahead of 2017 results. If we strip out the impact of currency profit, the increase was 17%. This was right in line with our expectations (EUR 8.1 billion) and 4% ahead of consensus (EUR 7.8 billion). Surprisingly, the market did not seem to like the results, with Santander trading 4% lower on the day. Santander generates around 60% of its pretax profits from Brazil, Mexico, and the United Kingdom, and we believe the heightened political risks in these countries weigh on Santander's share price. We maintain our narrow moat rating and EUR 5.30 fair value estimate.

Santander has significant exposure to Brazil and Mexico, which respectively accounted for 35% and 8% of its 2018 underlying pretax profits. Both of these Latin American giants have seen political uncertainty increase meaningfully over the past year or so. Executive chair Ana Botín seemed at ease with the situation, however, indicating that she has met with senior representatives of the new governments in both countries and that there is no cause for concern. Further political uncertainty comes from Santander's exposure to the U.K., where it generated 13% of its 2018 pretax profits. On this topic, Botín was less sanguine, indicating that a no-deal Brexit would have a negative impact.

Santander remains one of the few European banks that consistently earns a double-digit return on tangible equity. For 2018, it increased its profitability to 12.1% from 11.8% in 2017. This was achieved while adding nearly 50 basis points to capital with Santander's fully loaded core equity Tier 1 ratio improving to 11.3%. While Santander's capital adequacy remains meaningfully below the rest of the European banking sector, we remain unconcerned. First, Santander's profitability is high enough to support organic capital generation, as shown by this set of results. Second, in the most recent round of European Banking Authority stress tests, Santander had one of the lowest levels of capital depletion in Europe. Last, Santander has limited risk that its capital adequacy will suffer from risk-weighted asset inflation as the regulators take a stricter stance to internally calculated risk weights.

Santander increased its midterm target for return on tangible equity to 13%-15%; the previous target was 10%. Its capital adequacy target now calls for a fully loaded CET1 ratio of 11%-12%; the previous target was 10%. Considering that Santander is already at a CET1 of 11.3%, this does not seem terribly ambitious. With a meaningful increase in profitability targeted, we struggle to reconcile this unless there are plans to return capital to shareholders. Santander will provide more detail on these targets at its investor day in April.