Description

This a tremendously beaten stock of an Italian specialty finance company. The compelling investment case based on the wide and unjustifiable discount embedded in the market price. The potential upside is in excess of 100%.

BACKGROUND

Banca Sistema SpA (“Banca Sistema” or “Company”) is an Italian small and specialty finance bank providing (i) Factoring of receivables toward public administrations (68% of the total turnover) and (ii) Salary/Pension secured loans (28% of the total turnover). Outstanding loans exceed €2.5bn. Total funding is more than €3.5bn equally split among wholesale and retail channels.

Two banking foundations (collectively 15%) and the management (23.1%) retain the control of the Company through a shareholders’ agreement grouping 38.1% of voting rights (lock-up until June 2020). The remaining shares are floating with a diversified base of institutional investors.

MARKET PRICE

The stock was floated (Milan) in 2015 at €3.75 per share outlining a 60% decline up to now. The performance was dramatic in 2016 with the stock collapsing to €2 per share. A further drop occurred in 2019, from €1.7 per share in April to the minimum €1.2 per share in August, in concomitance with the peak of the recent Italian political crisis recently solved with the new government.

INVESTMENT CASE

• The investment case emerges from the extreme divergence (50-60%) between the market price and the estimated intrinsic value of the business. This is a boring and unsexy business in a neglected industry (banking) under structural transformation. The durable decline of the stock resembled that of the listed banks as a whole and it has nothing do to with the economic performance of the business. The sector stock market prices experienced a strong decline in 2016, than a rebound in 2017 thanks to positive momentum of the Euro-zone economy. They further collapsed by the end of FY18 because of the strong political confrontation of the Italian populists-led government with the EU Commission and drop more by mid-2019 because of the mentioned domestic political crisis.
• Further reasons for the slight interest of the market for this stock potentially due to the (i) minor capitalization of the stock with a small bunch of analysts covering it and low daily volumes (ii) partially unsatisfying capability of the management to smartly convey the messages to the market, which I perceived listening to the latest conference calls.
• The Company operates in an expanding segment of the financial industry. Banca Sistema specialized on the receivables toward PAs and it is experiencing a huge growth of volumes. Annual expenses and investments of Italian PAs is in excess of €220bn while the size of the factoring market is nearly 10% of the market value. The structural delays of the PAs in paying its debts (not expected to be solved easily, despite the huge amounts of late payment interests due according to the European regulation) outline a visible market over the long term. According to the business plan, the management assumes a credible but prudent expansion, supported by the recent performance and the current trading.
• As mentioned above, similar to the other Italian banks, the Company has been suffering a country risk effect. However, while the traditional banking business has been experiencing unsatisfying profitability since many years, Banca Sistema had a vigorous performance. The return of capital is close to 20% and projected to remain high over the plan. Current multiples (P/e 4x and P/BV 0.7x) are unjustifiably low for such a business.
• There is the right alignment of interest among controlling shareholders, the management and minority shareholders. The management retains 23% of the equity. The CEO acquired 170,000 shares in June when the stock traded at around 1.15. Other insiders acquired in August at prices slightly higher. Should the market price remain depressed, there could be the case for (a financial investor or a strategic one) setting a market transaction to buy-out the Company with an interesting discount. At June 2020, the current shareholders’ agreement will expire and potentially the Company will be contestable. The Foundations are long-term shareholders but they might consider exiting the investment should a potential buyer present a satisfying tender. The CEO is the key person at the Company and any investor shall probably engage him for a deal involving Banca Sistema.

FACTORING OF RECEIVABLES

Factoring of receivables toward Italian PAs is the key reference market for the business (valued €10bn according to the most recent estimate) because of the structural delay of the Italian PAs to pay their outstanding commercial debt (estimated at €55bn with an average paying time exceeding 100 days). The PAs suppliers (customers to Banca Sistema) who use the factoring facilities are utilities and companies providing healthcare products/services (including pharma companies), food, transport and entertainment services to the PAs. The most relevant obligors are typically the local state-owned healthcare companies (“ASL”), regions, municipalities, ministries. Banca Sistema’s turnover is mostly no-recourse factoring (78%), with recourse factoring representing just 12% and tax receivables 10%.

The Company originates the business through the direct channel (65%) with its offices in the key cities and the indirect one (35%) thanks to commercial agreements with banks and intermediaries/brokers.

The profitability of the business arises from the ability (i) to collect purchased receivables faster than the original creditor / customer (ii) to get a recovery value higher than expected by the seller. The payment time for each debtor is estimated during the underwriting, based on the Company’s proprietary tools and analysis that is continuously populated and updated with information and data on any single PA. Key strengths of the Company to effectively operate and price the products are: (i) a disciplined underwriting approach based on the proprietary database of the PAs, (ii) established relationships with the key people at the selected PAs and (iii) high specialization in collection.

The Company adopts a systematic approach for the collection of receivables and it privileges extrajudicial agreements with the obligors based on a payment schedule; according to the model, late payment interests (8% at European level for all the PAs) represent an incentives for the counterparts to pay the debt and a negotiation tool for the Company to get the acceleration in the payment.

SALARY/PENSION SECURED LOANS

This kind of secured (salary-backed or pension-backed) loans were established in the 50s. The loan is repaid directly by the employer (for employees) / social security institutions (for the pensioners) with the monthly installment that cannot exceed 20% of the net salary/pension. The loan repayment is privileged against any other seizure of the salary/pension; in addition to that, an insurance is mandatory by the law and cover the risk of death, disability and loss of job.

Nearly 50% of the business is with pensioners and other 33% with PAs’ employees highlighting a particularly low risk profile of the borrowers.

The business is originated through agreements with mediators and recently the Company acquired a broker (“Atlantide”) to generate internally the business.

The business has a dedicated funding channel following the securitizations of loans; the notes are retained by Banca Sistema and used as collateral to get access to the ECB funding and RePos with banks. 

HISTORIC FIGURES

Following the IPO in 2015, the Company posted a remarkable growth with assets jumping from €2bn (2016) to €3.1bn (2018) and recorded a stable profitability with net profit in the region of €26-27m.

The margins of the business resulted stable because the Company diversify the business mix, strongly expanding into the Salary/Pension-secured loans, a business that envisages lower interest margin because of the overall very low risk of this financial product. In 2018, factoring turnover and outstanding grew by a solid 20% but the secured-loans segment outpaced the factoring growth expanding by 30%. The adjusted interest income margin set at 470 bps in 2018, down from 550 bps in 2017 (product mix) consistent with the strategic plan targets.

As of the end of FY18, outstanding factoring loan amounted to €1.7bn while outstanding secured loans were €0.7bn. Appended below a slide directly from the Company presentation with the key highlights:

As far as the recent performance is concerned, the half-year 2019 data highlight solid growth both for the factoring (+17% y/y and +5% q/q) and secured loans (+32% y/y and +6% q/q) with stable outstanding breakdown.

QUALITY OF ASSETS

Net NPEs amounted to €196m (8.3% of net loans) as of the end of last year and resulted nearly stable as of end of June 2019 (reducing to 7.6% of net loans portfolio).

Cost of risk was in the region of 30bps in the last couple of years and surged to 38bps in the first half 2019 but remains pretty low. It was abnormally high in 2016 as per the deterioration of the loans portfolio toward SMEs (the business is in run-off).

Past-dues stock is mainly attributed to no-recourse factoring receivables towards PAs, which is typical (considering the kind of assets purchased by Banca Sistema), and factored into the purchasing prices of the loans. The recent jump in UTPs was due to a single name due to the lengthening of the recovery time but with no concern for the recovery of capital and interest according to the management.

Coverage ratios appear modest but it is important to bear in mind some key peculiarities of the business model: most of the bad loans are toward local municipalities or regions in financial distress (not private companies, so with a meaningfully lower credit risk despite the payment delays; the local municipalities cannot default and are not subject to the Italian bankruptcy law). A large share of the bad loans was purchased having clear the financial situation of the obligor; that made possible the purchase with a significant discount to take into account the time value.

REGULATORY CAPITAL

The Company exhibited 11% CET1 and 13.7% total capital as of the end of 2018 (similar figures as of June 2019). It is worth noting that at the end of 2018, ECOFIN approved the reduction of the risk weighting for Salary/Pension-secured loans with a positive impact on the ratios (150-200 bps); it is expected to occur shortly (still waiting for date of entry into force of the amendment). The improvement of the capital ratios is a critical factor in order to support further growth of the business.

BUSINESS PLAN

In 2018, the Company set a 3-year plan envisaging:

• Factoring turnover CAGR at 18% touching €3.3bn in 2020
• Outstanding Consumer loans CAGR at 25% reaching €1.0bn in 2020

According to the management, the plan will support 18% ROE over the plan period maintaining a solid capital base.

The key profit&loss figures expected to be:

• Adjusted interest income margin (calculated as the Interest Income / Average end of net customer loans, excluding the contribution from securities portfolio, credit due from banks and RePos) at 400-450bps (currently at 450-470 bps, but expected to decline as per the pressures on margin coming from further easing of monetary policy).
• Funding cost stable at 1%
• Cost of risk 30bps
• Cost / income ratio at 47%, consistent with the current level
• Net Income and EPS 2021 at, respectively, €34m and €0.41.
• CET1 ratio to remain close to 11% (excluding any positive effect from expected change in weighting of secured loans) with a projected 25% payout ratio.

VALUATION CONSIDERATIONS

The market cap of the Company stands at nearly €115m. With 80.3m outstanding shares, EPS set at €0.34 in FY18 and expected at €0.35 in the current year. The dividend payout (25%) assured €0.09 per share. At the current market price (€1.43), earnings yield stands at 24%, the P/e multiple sets at 4.1x while the dividend yield is in excess of 6%. According to plan assumptions and figures, the multiples for 2021 would be, respectively, P/e 3.4x and P/BV 0,5x.

With a 2019 expected ROE being around 17%, estimate of the intrinsic value could be nearly €270-280m that corresponds to a fair 10x expected earnings. In terms of price per share that would mean €3.5 outlining more than 100% potential upside for the stock.

Catalyst

- A potential deal regarding the company (M&A and/or Buy-out) at the current market price

- Formal adoption of change in weighting of secured loans (lower RWAs) in relation to Salary/Pensio-secured loans

- The change in country risk perception observed in the market prices of Treasuries to spread over the bank stocks