Itau Unibanco Holding SA (ITUB, Financial) is one of the largest private banks in Latin America and operates in various banking segments, from personal to large companies loans, insurance, wholesale services, asset management and the like.
The bank stands out for its almost impeccable track record, combining growth with profitability, as indicated by its return on equity of close to 20%, allowing for an attractive return on dividends. In addition, the bank has very good quality indicators and is generally above its main Brazilian peers.
Even in this scenario of dominance, given the maturity of its operations and the “Brazil risk,” the bank is trading at compelling multiples, such as a price-earnings ratio around 9, making the thesis a quality, value and dividend play.
Overview
As previously mentioned, the Brazilian bank offers a full range of services for individuals, but also corporate, investment banking and other services, analogous to a “Brazilian JPMorgan (JPM, Financial).” This diversification is reflected in its credit portfolio, which already exceeds 1.18 trillion real ($348.79 billion), divided between Individuals (~35%), corporate (~32%), small companies and Latin America. Of course, within these segments, there is also enormous diversification, with exposure to different credit risks and industries. It also does not have much dependence on a few players, as its largest debtor owes $5.60 billion, while the 100 largest debtors owe approximately $126 billion. This does not mean if there is a widespread crisis Itau would not be affected, but compared to other players (such as Bradesco (BBD, Financial)), its track record is better.
In addition to this factor, it is worth drawing attention to the evolution of the portfolio over the last 10 years, maintaining good levels even in more difficult periods for the Brazilian economy, such as in 2016.
Source: Itau Unibanco's IR
The delinquency over 90 days rate, or nonperforming loans ratio, also has an exceptional track record. Even at its peak in 2016, this ratio was just under 4%, which still guaranteed a ROE of almost 20% for the bank. In the most recent period, even with a high Selic Rate and a sluggish Brazilian economy, the bank has maintained its delinquency rate at around 2.70% (first-quarter 2024) on a consolidated basis and a growing portfolio. In the same period, the rate for the Brazilian National Financial System was around 3.20%.
Adding the growing portfolio, controlled delinquency with a lower cost of capital and Itau's efficiency, we have an also extraordinary and advancing ROE of around 21.90% in the last quarter, resulting in a recurring result of 9.8 billion real in one quarter. Doing a back-of-the-envelope math, if the bank manages to maintain the same level of profit in the coming quarters, we would have a price-earnings ratio of approximately 7.60 for 2024, a very attractive level considering the company is one of the most consolidated banks in Latin America, very profitable and with exposure to a lower level of risk than its peers have, such as exposure to riskier credits or state interference. The safety of the thesis is also reinforced by the capital the bank holds. In March, Itau's Tier I Capital ratio was approximately 14.50%, of which 13% was CET1 and the rest AT1. The minimum required by the Brazilian Central Bank is 11%.
This optimism is also reinforced by the guidance for 2024, which indicates interesting growth for the credit portfolio and for financial margins alongside controlled expenses.
Source: Itau Unibanco presentation
Another recent historical factor that reinforces Itau's quality is the narrative of digital banks versus big banks, where it has proven itself as a good company and has managed to reinvent itself in a dynamic and highly competitive environment. In the meantime, with the threats caused by Nubank (NU, Financial) and Inter (INTR, Financial), Itau has made strategic digitalization moves, with the creation of ĂŤon and the acquisition of XP (which has already been spun off) and Avenue, expanding its addressable market and showing the bank is never standing still.
A comparison of peers
None of these indicators would be enough to support the investment thesis if they were worse than their peers, but this is not the case. Itau has been among the banks with the highest ROEs for decades, when compared to its Brazilian peers Banco do Brasil (BDORY, Financial), Bradesco, Nubank and even when compared to JPMorgan. It is also worth noting the work Nu Holdings has done in recent quarters, managing to outperform the ROE of Itau and other large banks through its digital scale model, even with a smaller presence in corporate credit.
Due to its dominance and market share, it is also always among the highest net income figures. The bank has already reached an amount of almost 10 billion reals (9.8 reals recurring managerial results) in the last quarter alone. This alone shows the bank's robustness and also its attractive valuation, since annualized this profit would be around 40 billion reals, and it trades at a market cap of 302 billion reals. In addition, in the chart below you can see players like Bradesco are in a very difficult situation, suffering from high defaults (partly non-recurring) and lower efficiency.
Nu Holdings' net income is also noteworthy since, despite its slightly lower level ($1.27 billion), its market cap exceeds $100 billion, highlighting the high expectations for the digital bank (which, in my opinion, are justified).
In view of this net income and the fact the bank is trading at interesting multiples, with a payout of just over 60% (the historical level is slightly lower than this), we also see a good return via dividends. It should be noted that Banco do Brasil also has excellent indicators and a substantially lower price-earnings ratio, but this is due to the fact it is a state-owned bank, which even with an exceptional track record has the risk of government interference that Itau does not have, which is even more latent in times of a weaker economy or governments with a more statist bias.
As you can see from the chart below, Itau is trading at an earnings multiple of around 9, which is already attractive. This figure improves even more when projected over the next 12 months, dropping to something close to 7.30, below what has been observed in its history and even below the history of the financial sector of the Brazilian stock exchange.
Although Itau is still among the leading banks in Brazil by some metrics, such as total assets and the size of its credit portfolio, it is necessary to mention how dynamic the Brazilian market is, with digital banks conquering a good part of the business-to-consumer market share. The five largest banks have gone from representing 99.90% of all business-to-consumer transfers to something close to 42.40% in December 2022, a drop that has occurred due to the advance of platforms such as MercadoLibre's (MELI, Financial) Pago, Nu, Inter and other digital players. But as already mentioned, Itau has managed to play the “new game” well, innovating and remaining relevant, which mitigates some of the risks of competition.
The main risk is Brazil
Based on the information above, you can see Itau really is a bank out of the curve in the Brazilian scenario. In the net income graph below, the evolution of the bank's earnings over the years is clear, but there is a catch: the net income is in Brazilian reals. In the analysis of earnings in dollars, there has been stagnation over the last 10 years, since there was a significant currency devaluation in the period.
Source: Koyfin
In other words, the problem lies in the Brazilian macroeconomic scenario. Although Itau is practically an international bank, its operations are very dependent on Brazil and its earnings are mostly made up of Brazilian reals, bringing uncertainty to the thesis and making it more cyclical since Brazil's exchange rate effect depends not only on factors such as fiscal and monetary policy, but also from commodity cycles.
Not only that, but the bank's shares are also directly affected by changes in the perception (and flow) of the Brazilian economy. Currently, the outlook is not the best, with low confidence in domestic fiscal policies, along with a lack of conviction in large falls in the Selic rate influenced by the high level of U.S. federal funds rates.
In any case, even in the most chaotic scenarios, Itau manages to maintain extremely solid and profitable fundamentals. This can be illustrated both by 2016, where the Selic rate was also at a high double-digit level along with weak economic activity, or by the more recent period of 2022 and 2023 where the Selic rate returned to a level above 13% and yet Itau kept growing profit and with a ROE of around 20%.
Source: Banco Central de Brasil
In the same way the high Selic rate ends up putting pressure on economic activity and the adverse outlook for this is an obstacle, the fall in the rate that should happen in the coming quarters should also help the bank's results (with lower delinquency, lower cost of capital and greater growth) as well as the stock. Although the market expects few cuts to the Selic rate over the next few years, with 2026 futures trading at around 0.50%, the central bank's Focus Report already estimates a Selic rate of 9% for 2025, which seems feasible (and even conservative) if inflationary pressures and the global environment cooperate.
The bottom line
Although for international investors Itau is a cyclical play, given its exposure to Brazil and the relevant effects of the exchange rate, there are some factors that make the thesis safer. The bank's quality indicators make it less sensitive to worsening macroeconomic conditions when compared to other Brazilian banks, which means that, even in a more adverse scenario, Itau should continue to present good, strong fundamentals.
To see how cheap Itau Unibanco might be, I used the discounted cash flow calculator (based on EPS) to understand which assumptions the market makes about the current share price. Using an earning per share growth rate of 4% for the next 10 years, 0% for the terminal stage and discounting the shares by 13% (above the terminal Selic), we find a price of $6.57, slightly above the current screen price. The market currently prices little growth (in dollars) for the future in conjunction with a high discount rate.
As a consequence, the thesis should also demonstrate an interesting cost of carrying through its attractive dividend yield, also considering the low price-earnings ratio of 7.30. The bank presents itself as a good way of building exposure to Brazil, but through a high-quality company that combines the factors of value, dividends and quality.
As a disclaimer, it's worth mentioning that not only Itau, but several other shares in Brazil, are also showing a certain attractiveness, especially in terms of price. This discount is mainly caused by the current economic scenario, with high interest rates and global macroeconomic uncertainties.
