Itau Unibanco’s strategy of trying to be everything to every consumer and business isn’t unusual in the world of banking. The major US banks have adopted a similar strategy over time, providing core banking services like deposits and loans, but also insurance products, equity investing, and a host of other products to help attract customers.
However, what sets Itau Unibanco apart is its exposure to emerging economies, rather than established ones in Europe or the US.
Source: Investor presentation, page 87
Indeed, the above chart shows Brazil’s GDP deficits for the past several years, and the trend is clear. It has been a very long time since Brazil has shown positive economic growth, and many of the other countries Itau Unibanco operates in are in similar, if not worse, situations.
This is a primary concern for us regarding the company’s ability to grow, because the business model of a bank requires broad economic growth for its own expansion. Without this growth, Itau Unibanco will have a difficult time producing profit expansion.
Source: Investor presentation, page 89
We can see the impact of this weakness, among other factors, in the company’s Q1 results. Itau Unibanco has spent years trying to reduce its non-interest expense because its earnings are exposed to a weakening Brazilian economy. This is certainly a factor in its international expansion, and while diversification is a good thing, the worldwide economic shutdowns as a result of COVID-19 are also discouraging.
The credit portfolio grew nicely from Q4, adding nearly 9% in just one quarter. Non-interest expense pulled back as well, falling 7% quarter-over-quarter thanks to intentional hiring limits and other cost saving measures.
However, expected losses have soared since the beginning of 2020, so we are quite cautious after Q1 results.
Source: Investor presentation, page 92
Itau Unibanco has taken huge loan loss provisions in the past year, with that total rising 38% since last year’s Q1. The retail segment has seen its expected losses soar 73% higher in the past year thanks to rapidly deteriorating credit quality among consumers.
In short, losses like this will take some time to recover, and if there is another worldwide economic shutdown due to COVID-19, they will almost certainly become a lot worse.
Source: Investor presentation, page 95
Higher losses aren’t the only problem Itau Unibanco faces. The cost of credit has risen substantially in recent months, driving the poor performance shown above. Higher credit cost has caused the bank’s margins to plummet, particularly on a risk-adjusted basis. While Q1 was impacted by COVID-19, shutdowns didn’t occur until very late in the quarter. We expect Q2 results to be worse than this, with the outlook for returning to normal for Itau Unibanco quite murky.
We see the path to any growth ahead for Itau Unibanco as difficult, and expect a flat long-term EPS for the next few years, following the decline this year and rebound into next year. Under normal conditions, we still expect the bank to struggle to grow.
Dividend Analysis
Itau Unibanco has a conservative approach to paying its dividend. The bank pays out dividends to shareholders based upon its projected earnings and losses, with the goal being the ability to continue to pay the dividend under various economic conditions.
The bank’s current payout equates to just 4 cents per share annually on its US listing, which is good for a current yield of 0.8%. Thus, Itau Unibanco isn’t a pure income stock by any means, as its yield is simply too small to be attractive to income investors.
On the plus side, this very small yield affords the bank strong dividend coverage. Current estimates for this year are for 40 cents per share in earnings, good for a payout ratio of just 10%. We therefore do not see any risk of a dividend cut today, but we are also cautious on future growth given the uncertain outlook for Brazil’s economy. Thus, we do not believe income investors should be interested in Itau Unibanco stock, due to its fairly low yield and the number of elevated risk factors.
Final Thoughts
We see a difficult road ahead for Itau Unibanco. With little to no projected earnings growth under normalized conditions, as well as a diminutive yield, we don’t view this stock as attractive.
At the same time, buying international stocks carries multiple unique risk factors, including geopolitical risks and currency risk, among others. Itau stock does provide geographic diversification for investors who are particularly interested in investing outside the United States.
However, the risks seems to outweigh the potential rewards for this stock. Given all of the above factors, we recommend investors avoid Itau Unibanco, despite its monthly dividends.
