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Morningstar | Societe Generale Lowers Guidance

No-moat Societe Generale reported net income of EUR 3.9 billion for the 2018 fiscal year, somewhat stronger than the EUR 3.7 billion we had penciled in. Socgen did, however, reduce its previous guidance through to 2020. After incorporating the reduced guidance, we reduce our fair value estimate to EUR 33 per share from EUR 42 per share previously.

In response to Socgen's revised guidance, we reduce our net income estimates for 2019 and 2020 by 8% and 17%, respectively. There are several main drivers of our lower estimates. The first driver is lower net interest income. Socgen now sees interest rates to remain low through 2020, and its lower interest rates assumptions will lead to a EUR 500 million decline from what Socgen previously believed would be possible to generate as net interest income by 2020. We include this lower guidance in our estimates.

The second driver is lower trading income. Socgen did not provide explicit guidance on its expectation for the trading line; 2018, however, disappointed relative to a 2017 base that was already depressed. We believe it is highly unlikely that there will be any recovery in a more difficult environment where Socgen is also reducing capital allocated to trading activities. Our previous expectations for trading income now look decidedly bullish. We pull back our estimates for 2019 and 2020 sharply, by around 25%. Combined, our lower net interest income and trading income expectations drive down our overall revenue estimates for 2019 and 2020 by 3% and 7%, respectively.

The other driver is operating leverage magnifies lower expected revenue. While we believe that Socgen will achieve its 2020 operating expenses target of EUR 17.8 billion (currently it is EUR 17.6 billion), it will not be enough to absorb the lower revenue guidance. Socgen's previous cost/income ratio target of below 63% looks virtually impossible to meet--our estimates suggest a cost/income ratio of 69% by 2020.

Socgen revised its return on tangible equity, or ROTE, target to 9%-10 % from 11.5% previously. Our estimates suggest that Socgen's ROTE will be around the bottom end of the range by 2020. It is important to note that our midcycle ROTE is lower because we believe that Socgen's loan loss provisions are meaningfully below where we see its midcycle loan loss provisions will be.