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Equity Research: Banco Espírito Santo Group

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Equity Research: Banco Espírito Santo Group CATÓLICA LISBON SCHOOL OF BUSINESS & ECONOMICS Equity Research: Banco Espírito Santo Group Ana Catarina Ferreira da Mata, 152110016 Advisor: José Tudela Martins Dissertation submitted in partial fulfillment of requirements for the degree of MSc in Business Administration, at the Universidade Católica Portuguesa, June 4 2012 Abstract This investment advisory service is supported by some of the most adequate valuation frameworks discussed throughout the literature review, whose purpose is to break down the best quantitative assessment of the financial institutions’ equity and come up with a final price target. Thereby, an insightful analysis is provided, in which the source of research is a listed financial institution in PSI20 index – Banco Espírito Santo, the largest capitalised bank in Portugal. At the end of this dissertation, all the valuation metrics under analysis and the rational will be closely compared to Caixa Banco de Investimento’s banking report published on December 13 2011, an up-to-date sector report of the Portuguese banks challenges. 2 Table of Contents PREFACE ................................................................................................................................................................................. 5 EXECUTIVE SUMMARY ...................................................................................................................................................... 6 INTRODUCTION ................................................................................................................................................................... 8 I. LITERATURE REVIEW .............................................................................................................................................. 9 A. VALUATION APPROACHES AT A GLANCE ..................................................................................................................................... 9 B. COST OF CAPITAL APPROACH .................................................................................................................................................... 10 C. EQUITY CASH FLOW MODEL ....................................................................................................................................................... 12 1. Saying no to the Use of Option-Pricing Theory...................................................................................................... 13 D. DIVIDEND DISCOUNT MODEL ................................................................................................................................................... 13 1. Measuring the advantages and disadvantages of DDM ..................................................................................... 15 E. EQUITY EXCESS RETURN MODEL ............................................................................................................................................. 16 1. The Feltham-Ohlson Model (FOM) ............................................................................................................................. 16 2. Problems associated with Residual Income Model .............................................................................................. 18 F. RELATIVE VALUATION ............................................................................................................................................................... 18 G. DUPONT ANALYSIS FOR BANKS ................................................................................................................................................. 21 1. Limitation of Dupont Analysis ...................................................................................................................................... 22 H. CROSS-BORDER VALUATION ...................................................................................................................................................... 22 I. FINAL REMARKS .......................................................................................................................................................................... 24 II. BANKING INDUSTRY OUTLOOK ........................................................................................................................ 25 A. INTERNATIONAL BANKING AFTER THE RECENT FINANCIAL CRISIS ..................................................................................... 25 1. The Globalisation of Financial Markets.................................................................................................................... 25 2. Portuguese banking system ......................................................................................................................................... 29 B. BANKING PROFITABILITY AFTER THE RECENT FINANCIAL CRISIS ....................................................................................... 30 C. BASEL III ACCORD ....................................................................................................................................................................... 32 D. TROIKA MEASURES FOR THE PORTUGUESE FINANCIAL SECTOR .......................................................................................... 33 1. Liquidity ................................................................................................................................................................................ 34 2. Deleverage programme .................................................................................................................................................. 34 3. Capital buffers .................................................................................................................................................................... 34 4. Caixa Geral de Depósitos ................................................................................................................................................ 34 5. Solvency and liquidity ...................................................................................................................................................... 34 6. Regulation and supervision ........................................................................................................................................... 35 7. Corporate and household debt restructuring ........................................................................................................ 35 8. Corporate and household monitoring ....................................................................................................................... 35 E. EBA’S EU STRESS TEST IN 2011 ............................................................................................................................................. 35 1. General analysis by country .......................................................................................................................................... 36 2. Espírito Santo Financial Group stress test results ................................................................................................ 38 III. BES DEVELOPMENTS ............................................................................................................................................. 39 A. BES GROUP PRESENTATION ...................................................................................................................................................... 39 B. MAIN INDICATORS ....................................................................................................................................................................... 40 1. Activity ................................................................................................................................................................................... 40 2. Profitability ......................................................................................................................................................................... 42 3. Liquidity ................................................................................................................................................................................ 42 4. Asset Quality ........................................................................................................................................................................ 43 5. Efficiency............................................................................................................................................................................... 44 6. Solvency................................................................................................................................................................................. 45 IV. VALUATION METHODOLOGY ........................................................................................................................ 47 3 A. VALUATION STRUCTURE ............................................................................................................................................................ 47 B. VALUATION ASSUMPTIONS ........................................................................................................................................................ 47 1. Core items forecast – Liability side of the balance sheet ................................................................................... 47 2. Core items forecast – Asset side
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