The mainstream media is all over the story of the demise of Deutsche Bank, which suggests we have entered the denouement. We use OTAS to assess what is currently factored into the share price as the consequence of any rescue deal for the bank.
Over the past ten years Deutsche has fared no worse than the average European bank, although of course it is supposed to be an above average player, both in terms of international investment banking and among the low return retail banks in Germany. Yet the combination of return on assets and return on equity is forecast to be the worst in the sector this year and next, meaning that for all its leverage, Deutsche’s core return is simply too low.
Over a decade, the share price is down 70%, as is the average European bank, while the European market as a whole managed a near 2% rise. By way of comparison, BNP Paribas is down just over 10% during the same period.
OTAS Technical analysis describes Deutsche as a falling knife; a stock trading below its significant moving averages and one that has yet to trigger signs of a turnaround. EPS Momentum is -9% over the past month, which unsurprisingly is in 95th percentile of the European diversified financials industry. There are, however, several banks and financial companies where short term momentum is worse.
Since the beginning of Q2 2012, forward estimates of Deutsche’s earnings have fallen 75%, while the share price is down around 70%. A further 15% fall in the share price is implied were it to match the change in EPS over this period. Once talk of bail outs goes mainstream, however, 12 month EPS forecasts move to the periphery of the investment debate.
The downgrades have pushed Deutsche’s forward P/E ratio to the highest on record and it recently touched a premium to the sector that surpassed the level reached in April 2009. Perhaps more significantly, the price to book ratio of 0.24x is below the low point reached during the financial crisis in 2008-9. At one third of the average rating of the sector, the prospects for recovery of Deutsche’s net asset value have never looked worse.
Throughout this time, the short interest in the shares has been surprisingly benign, although the exceptional trading volume of late points to the action being in the cash market. The current level of free float shares on loan is in the middle of its normal range and seems unlikely to be a useful indicator of where the share price goes from here.
The question now becomes what a recapitalisation of Deutsche Bank looks like, assuming it is correct to assume that for all its hard-line rhetoric, the German government cannot let its largest bank go under. With the equity currently expected to return 25% of its value, what about the debt? The CDS trades at 232 basis points, an extreme level over the last decade, but not the highest point reached in that time. Interest rates have fallen over this period however, so it is worth noting that at 1.9x the level of the average European financial, Deutsche’s debt is consider more risky than it has ever been.
For those who are prepared to bottom fish, there are a number of indicators in OTAS that might point to a turnaround in fortunes at some stage. One would be a stabilisation and then improvement in EPS Momentum, although history teaches that the share price will have moved before the analysts are ready to risk reputations on calling a buy. Thus OTAS technical signals, which focus on mean reversion, may provide an earlier indication of a bounce, especially if combined with another signal. This may be from the CDS market, because if debt investors start to relax about how many cents in the euro will be returned, then Deutsche’s shares should rally.
Stay tuned to OTAS, for it hasn’t happened yet.