Deutsche Bank (NYSE: DB) held a “deep dive” on strategy on December 10. The event was planned as a “fleshing out” of the new strategy the company presented to investors on July 8 (link), which involves a radical cull of the investment bank and a pivot back towards DB’s core retail, corporate and asset management activities.

Far from reassuring investors that the strategy can deliver the planned financial outcomes (8% ROTE by 2022), the event served mainly to underline what a pipe-dream the targets are and how easily they could be missed given the magnitude of the headwinds facing the company.

I continue to think DB will probably do well to get to half the 8% ROTE target by 2022. and I also continue to see a material risk of DB needing more capital before the restructuring is complete.

Given all of this, I continue to recommend avoiding the shares, even at the current depressed P/TNAV level of 0.3x. I’ve updated my fair value target, which is now €6.6, more or less where the shares currently trade.

A deep dive into a deep hole

The “deep dive” started optimistically enough with CEO Christian Sewing stating that:

In the past few months we have made significant progress on every dimension of our strategic transformation. We are in line with our plan and even ahead in several areas (December 10, press release).

And investors could breathe a sigh of relief that none of the key financial targets from July was amended. These include:

  • Hard cost targets for 2019 (€21.5bn), 2020 (€19.5bn) and 2022 (€17bn).
  • 8% ROTE by 2022 and 9% for the core banks, excluding the newly formed “Capital Release Unit.”
  • Core equity tier 1 of at least 12.5% through the life of the plan.

However, that was about as positive as the message got. Even though we are hardly six months into the plan, the caveating has already begun.

Management said that the ROTE target “has become more ambitious given external headwinds, particularly interest rate developments in the euro area.”

Significantly, it also made a small but notable downgrade to the revenue ambition, which is now ~€24.5bn of net revenues by 2022 instead of ~€25bn targeted in July.

In addition, management changed the composition of the target, downgrading the contributions from the Private (Retail) Bank and the Asset Management division and upgrading the contribution from the Investment Bank.

The Private Bank is now expected to post no growth to 2022 (vs. the original plan of 2% pa growth) while Asset Management is expected to post only 1% pa growth (vs. 2% previously). The growth contribution from the Investment Bank has been upgraded from 0% to 2% pa.

Source: Investor Deep Dive presentation, December 10

This is a bizarre change of stance and most investors will be flabbergasted that DB is once again pinning its hope on precisely the business it is currently dismembering, while de-prioritizing the businesses it heralded as core to its future just a few months ago.

Sadly, it’s the sort of randomness in strategic thinking investors have become accustomed to and it mostly serves just to undermine what little credibility the revenue targets had in the first place.

Even in spite of an absence of top-line growth in the Private Bank and Asset Management, DB is sticking to its ambition to substantially improve ROTE by 2022, envisaging an increase in the Private Bank ROTE from 4% in 2018 to 10-11%, from 9% in the Corporate Bank to 12-13% and from 2% in the Investment Bank to 7-8%.

Source: Investor Deep Dive presentation, December 10

The revenue hole is as deep as ever

None of this should come as a huge surprise. As I noted in my last article on DB, the company is in a deep revenue hole.

Over the last seven quarters revenues have been in unrelenting decline with 3Q19 revenues being a full 25% lower than 1Q17.

The fact that over this period risk-weighted assets have only fallen by 3% and leverage assets by 8% points to much higher “collateral damage” to revenues than had been anticipated as disruption and uncertainty have seen contraction in businesses the bank wants to keep.

Source: company disclosures

Revenue erosion has also impacted almost all divisions and not just the Investment Bank where most of the recent restructuring has been focused. 9m revenues in the Private Bank were 5% lower YoY and 1% lower in Asset Management. Only the Corporate Bank has posted growth so far this year but its level of 2% YoY is also below the 3% targeted in the plan.

Source: company disclosures

The fundamental problem with DB’s 2022 financial plans is that they hinge crucially on the company being able to deliver the €24.5bn revenue target in 2022.

The company provided a helpful waterfall diagram this week showing the steps needed to get from 0% ROTE currently to 8% in 2022. Revenue growth accounts for up to 3% of the gap.

The wavering we’re starting to see is therefore particularly ominous.

Source: Investor Deep Dive presentation, December 10

The range of possible ROTE outcomes is wide

The above slide suggests that if DB can’t deliver revenue growth, then ROTE by 2022 will be stuck at around 5-6%.

The outcome could be worse because DB has based its numbers on 9m19 revenues which include six months of the bank in its pre-July, pre-restructuring state, with a full-service investment bank.

A more realistic revenue starting point is probably to take annualized 3Q, at which point the IB restructuring was already underway. On this basis, revenues are €21bn. If we plug in the company’s 2022 expense target (€17bn) and realistic assumptions for loan losses, taxes and a residual loss from the CRU unit, ROTE in 2022 on this basis is just 3%.

This gives a plausible range of 2022 outcomes:

  • 8% ROTE if DB can grow revenues by 2% pa as per its plan.
  • 5-6% ROTE if no growth is achieved versus the 9m19 revenue level.
  • 3% ROTE is no growth is achieved off the annualized 3Q19 starting point.

Source: author’s calculations

Assigning probabilities to the range of outcomes yields a fair value target of €6.6

This is obviously a wide range of potential outcomes with widely varying valuation implications.

A way of bridging such a huge range of outcomes, that I introduced in my last article on DB, is to assign probabilities to each and to calculate fair value on a probability-weighted basis.

I’ve updated these calculations below for the new information given this week, especially DB’s estimate of “no growth” ROTE of 5-6%.

I still think flat revenues on the 3Q annualized level is the most prudent assumption, so I’ve assigned this scenario the biggest probability of 50%. I’ve assigned a 30% probability to DB’s no-growth 5-6% estimate and just a 20% probability to full-achievement of management’s 8% ROTE target.

This methodology suggests probability-weighted fair level is around €6.6, which is the current share price.

With no upside, weak recent earnings reports and still huge uncertainty over the 2022 targets, I recommend continuing to avoid the shares.

Source: author’s calculations

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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