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How Could A Technical Default Impact Valuations?

Monday - 4/8/2013, 5:14pm  ET

Argentina is in a complicated situation. The country’s officials have repeated that Argentina will still seek to pay its debt abroad if the U.S. court appeals its proposal to restart a bond swap for the holdout creditors. However, this could have some intricate negative developments. The cost to insure against Argentina’s debt default has soared to record levels as five-year CDS (credit default swaps) are trading at 3754 Bps. The decision the country is waiting for is the review by the 2nd Circuit of Judge Griesa’s rule in favor of holdout creditors, indicating the country needs to place $1.3 billion into an escrow account. Only if Argentina enters into technical default, or BNY Mellon decides not to pay the bondholders in fear of the court’s rage, would the CDS trigger (clearly exacerbating the problem). How will this impact the stocks of Argentinean banks?

A technical default could knock down bank valuations in Argentina and could open up a great opportunity to buy shares of these already undervalued stocks. The banks I will evaluate are: Grupo Financiero Galicia , BBVA Banco Frances and Banco Macro .

The following chart can help us analyze each bank’s valuation:

Source: Company filings, Bloomberg.
 
Grupo Financiero Galicia exhibits an acceptable P/E ratio at 4.27x with an incredible 31.6% of ROE and an average 2.6% of ROA. This is probably indicating that investors expect high growth for the company in the future and that it is currently undervalued. It has a suitable 9.6% in capitalization ratio and its market share for private sector deposits and loans to the private sector are above some of its peers: 9.12% and 9.05%, respectively. It has a 7 million customer base (estimated 41% of Argentina’s economically active population) with a diversified private sector loan portfolio, 40% of its loan portfolio maturing in less than one month and a total deposits growth since 2008 of 27% CAGR (compound annual growth rate). Net income for 2012 was 1.336 Argentine pesos (ARS).

BBVA Banco Frances’ P/E ratio stands at 5.1x with a strong ROE at 28% and a 3% ROA. It's better capitalized than Galicia: 12%. Again, as with Galicia, Frances is a good opportunity if we consider its ROE and P/E ratio. Its market share of private sector deposits (7.7%) and loans to the private sector (6.7%) are behind Galicia’s. It has a diversified loan portfolio: 30% corporate loans, 38% consumer and 32% to companies with a great loan quality, as only 0.5% from total loans are considered with a doubtful return. Net income for 2012 stood at ARS 1.264.

Finally, Banco Macro’s P/E ratio is 5.0x with a lower ROE of 27.1% than its peers in this comparison and a 3.3% ROA. Its market share of private sector deposits is the lowest at 6.8%, but an average 8.1% regarding market share of loans to the private sector. Management has developed a conservative strategy as its operational efficiency (cost of income ratio) is 51.6%, with liquid assets at 31.7% of total deposits, and an excellent capitalization ratio of 19%. Its opportunities lie in increasing market share in the credit card market and generating loans growth. Its business model is oriented to low and mid-income individuals and small and mid-sized companies, as well as provincial governments. Net income for 2012 was ARS 1.494.

These banks pose a great opportunity, as they're currently undervalued if we evaluate their P/E ratio and their ROE. They have diversified loan portfolios with different strategies focusing at singular population targets; they're well capitalized, have a stable customer base, similar net income and have been posting deposits growth in the last quarters. A possible technical default could undermine these banks valuations even more, enabling investors to acquire these stocks at very attractive fundamentals, but exposing them to institutional risks that cannot be overlooked.

This article was originally published as How Could A Technical Default Impact Valuations?on Fool.com

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