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Analysts skeptical of Commerzbank's bold 2024 profit goals

Commerzbank AG's latest restructuring plan features its most ambitious profitability goals in nearly 10 years, yet analysts are not convinced the targets are achievable.

Like many other banks in Europe, Germany's second-largest listed lender is embarking on a major overhaul of its branch network and workforce, which analysts fear could limit the potential for revenue growth. Meanwhile, low interest rates are putting pressure on net interest income and margins, and more one-off charges could hamper the cost-cutting drive, further reasons for the mismatch between consensus forecasts and the bank's own targets.

Commerzbank's capitalization and underlying performance are considered good enough to keep the execution of its restructuring on track, but market observers are skeptical on whether the bank can make a clear break from years of low profitability.

Ambitious goals

Under its new strategy, Commerzbank aims for a return on tangible equity of 7% and operating profit of about €2.7 billion in 2024 — results the group has not seen in roughly a decade. The last time Commerzbank's pre-provision operating income was above €2.7 billion was in 2012, and the group's return on equity has exceeded 4% just once since 2011, with the average ROE between 2011 and 2019 standing at 0.7% and a negative ROE reported for 2020, S&P Global Market Intelligence data shows.

Nevertheless, the bank considers the midterm profitability goals achievable because of its most aggressive cost-reduction plan since 2012, which envisions the gross reduction of 10,000 full-time equivalent positions and about one-third of the bank's 790 branches in Germany. Commerzbank has guided for largely stable revenues during the restructuring as profitability will be underpinned by the planned 20% reduction in costs, or €1.4 billion, by 2024. At the new strategy presentation in February, CFO Bettina Orlopp said revenue should stand at about €8.7 billion and costs at about €5.3 billion in 2024.

"Our 2024 targets are valid," a spokesperson for the bank told Market Intelligence after its second-quarter earnings presentation, where CEO Manfred Knof also spoke about being "on plan" with the goals.

Analysts, however, doubt the group will be able to generate enough revenue to support the deep cost cuts and reach the level of profitability it aims for at the end of its restructuring. Average consensus estimates of analysts polled by Commerzbank in late July show that ROTE is expected to come in at 5.1% and operating profit at €2.13 billion in 2024. The common equity Tier 1 ratio is expected above the bank's guidance of around 13%.

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While consensus estimates for 2024 costs are better than the bank's target, revenue expectations are roughly €500 million lower than what Commerzbank has guided for.

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"Even allowing for material cost-cutting initiatives, we don't see Commerzbank reaching a ROTE of even 5% by 2024," UBS analysts said in a research note regarding Commerzbank's strategy in early 2021, citing "both revenue and cost challenges for Commerzbank and the market overall."

Société Générale equity analyst Saurabh Singh echoed this sentiment in a July 26 note, saying that while the new strategy is "aggressive," Commerzbank will eventually fall short of its 2024 ROTE target due to lower-than-expected cost savings and low capital flexibility. Singh also voiced concerns about revenue attrition, particularly in the group's corporate clients business as a result of the closing of 15 international locations and the difficulty of repricing.

Commerzbank's "obsession" with reducing costs will take a toll on revenue growth, which is key to improving the bank's profitability, CFRA Research analyst Firdaus Ibrahim said in an Aug. 9 note. Despite the bank's "ambitious" midterm cost reduction target, the planned cuts "are back-end-loaded, with seemingly little scope for further reductions if revenues disappoint," Berenberg analysts said in an Aug. 5 note.

Q2 and 2021 outlook

For some analysts, the group's second-quarter performance was indicative of the challenges that lie ahead. While Commerzbank's underlying results were good and came in above consensus estimates, overall earnings in the quarter were burdened by multiple one-off effects including extraordinary provisions and write-offs, analysts at Barclays, Deutsche Bank and Oddo BHF said after the Aug. 4 earnings release.

The negative one-offs were a reminder to investors that "the restructuring journey is not a straightforward one," Barclays' analyst Jun Yang wrote. The extraordinary charges affected the revenue-cost jaws Commerzbank had maintained over the previous five quarters, driving expenses up, while turnover fell quarter over quarter due to strong net interest income pressure.

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The bank's second-quarter earnings call was "solid" and management "did a reasonable job of explaining most of the moving parts in the very messy quarter," Citigroup equity analyst Nicholas Herman said in an email. Performance in the second half of 2021 should be "much cleaner" with potential for further reduction in loan loss provisions, Herman added.

Commerzbank cut its second-quarter loan loss provisions by 81% year over year, but this was not enough to offset €511 million of restructuring charges, a one-time write-off of €200 million for a cancelled outsourcing project with HSBC Transaction Services GmbH, and an 18% drop in revenue, the combined effect of which dragged the group into a net loss of €527 million. CFO Orlopp said the bank remains cautious and will keep the risk provisions buffer in 2021.

Share price drop 'a bit harsh'

The fact that Commerzbank announced the HSBC-related write-off so soon after it raised its restructuring costs guidance to €2.06 billion from €1.8 billion "will unnerve the market, which will be concerned that further negative one-offs are possible," Berenberg analysts said.

Commerzbank's stock has been on the decline since early June, dropping more than 5% after the second-quarter earnings release.

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According to Herman, the share price drop was "a bit harsh" given that Commerzbank's plan still looked "relatively on track" after the second-quarter figures.

Morgan Stanley equity analyst Izabel Dobreva said the 17% underperformance of the Commerzbank's shares as compared to the EURO STOXX Banks index over the past six months creates an upside. The group's targets are long-dated and execution risks remain high, but if Commerzbank delivers on its strategy "the stock offers major re-rating potential," Dobreva said in an Aug. 5 note.

Commerzbank is unlikely to reverse its underperformance versus the sector any time soon, but with the stock trading at a 70% discount to tangible book value, the existing market concerns are already priced in, the Berenberg analysts said. The group's price-to-tangible book value stands at 0.28x, compared to 0.45x for domestic peer Deutsche Bank AG, according to Market Intelligence data.