Banco Santander SA plc Could Beat The FTSE By 10%

Banco Santander (LSE: BNC) (NYSE: SAN.US), the eurozone’s biggest bank, almost doubled in 2013. More than half of Santander’s earnings are generated in emerging markets, which sold off heavily earlier this year, but of late there has been an uptick in sentiment.

Now that the panic is over, you’re too late to buy in and benefit from the recovery. Santander shares have increased by 17% year-to-date, although you needn’t feel disappointed, as in this analysis I’ll explain why there’s potential yet for further gains.

Why the shares are undervalued

SantanderThe eurozone crisis, which saw countries such as Greece, Ireland, Italy, Portugal and Spain weighed under by sovereign debt, led to banks losing billions in default loans and diving revenues.

Despite the recovery in the eurozone, which now has spread even as far as the periphery, businesses are yet to begin hiring. Unemployment in Spain, Santander’s home country, increased to 25.9% in the first three months of 2014, up from a revised 25.7% in the previous quarter.

This is a problem, of course, and the private sector is struggling to pay back its bank loans. A bank can roll over the loan — renewing the debt, or extending the repayment deadline — which is fine, as the banks have been able to do this at favourable rates. There’s a strain, however, between unemployment falling, the private sector strengthening its financial position, and interest rates eventually rising.

For these reasons investors are still skittish.

Take advantage of irrational behaviour

Earlier this week the World Bank downgraded its global growth forecast from 3.2% to 2.8%. Santander is a highly diversified business with major operations in South America, Continental Europe as well as the UK.

Santander, then, is still very much a recovery play. If the economic climate changes then the bank should prosper, and while there is less pessimism hanging over the shares, the prevailing outlook doesn’t fully reflect prospective earnings growth.

Santander is expected to grow earnings to 54p two years out, and the shares presently trade at 16 times last year’s earnings. If we tread cautiously, and assume the shares will trade on a P/E of 14, then this would imply a share price of 798p.

Assuming that the dividend will be cut by 20% this year (as is likely), and is held the year after, then the the shares could be priced at 829p in 2015. That beats the FTSE’s performance over the past two years by 10 percentage points.

How to asses your chances

To better assess your chances of making a profit from Santander, and the banking sector broadly, I recommend you read "The Motley Fool's Guide To Investing In Banks".

This free report contains essential step-by-step guidance on how to value a bank, which is a tricky prospects for non-experts in the field.

To receive you're free copy now simply click here.

Mark does not own shares in Santander.