After a mixed start to 2023, diversified Mexican banking group Grupo Financiero Banorte (OTCQX:GBOOY) stock has rallied strongly since I last covered the name. To a large extent, this outperformance was supported by another great Q3 result, as the combination of interest income resilience and an acceleration in credit growth led to Banorte outpacing expectations. With management also (conservatively) keeping guidance in place, expectations aren’t too lofty in the face of Mexico’s broader economic momentum and near-term fiscal boost ahead of elections later this year.
As with all banks, though, the catch here is an impending tradeoff between credit growth and net interest margins as we enter a rate cut cycle. For now, easing has come later than expected (Banorte sees cuts starting in May 2024), and ‘higher for longer’ Mexican interest rates have kept interest income resilient. Rate cuts will eventually bite into margins but management’s efforts to reduce interest rate sensitivity and persistent Mexican inflation pressures could still drive some upside surprises ahead.
Plus, the bank can always lean on robust loan growth, supported by structural tailwinds like ‘nearshoring’ and increased credit penetration, to keep profitability on the right track. The stock has re-rated slightly on book, but it isn’t all that pricey at ~8x relative to a low teens % recurring earnings growth potential. There’s also a bonus high-single-digit % payout on offer (including specials), so patient investors should still come out ahead.
Making Hay While the Sun Shines
Unlike many of its Latin American counterparts, Mexico has held off on monetary easing; in tandem, Banorte management isn’t penciling in rate cuts until May 2024, with rates only expected to hit 9.25% by year-end. That’s good news for Banorte’s near-term bank earnings outlook, as the same ‘higher for longer’ tailwind that boosted its Q3 net interest margin (+10bps sequentially) should flow through to Q4 as well.
Things will inevitably reverse, though management is also pre-emptively building up a higher fixed-rate asset mix (at a small cost to this year’s margins) to protect future earnings. The result is a significantly reduced rate sensitivity profile ahead of rate cuts later this year – the local currency book sensitivity has been cut in half over the last year to MXN650mn per 100bps of rate movement, while the USD book moves MXN880m for every 100bps. Management is still working this down, so expect another sizeable sensitivity reduction (guidance is MXN500m) next quarter.
Credit Momentum to Offset Expense Pressure
All eyes are focused on the bank’s growing hedge against lower rates, but it’s worth keeping in mind that credit demand is also poised to remain strong. And in the immediate term, economic momentum is likely to pick up ahead of an election cycle in H2 2023; Banorte stands out as a beneficiary from any fiscal boost. As for the mid to long-term, bank loan books are well-placed to benefit from powerful secular themes like ‘nearshoring’ and growing credit penetration, Net-net, the current mid-teens % growth algorithm seems well-supported.
The outlook for expenses is less upbeat. Capturing revenue opportunities will require higher spend, and Banorte is massively expanding headcount in anticipation. Digital bank Bineo will also weigh on the 2024 cost base, before (hopefully) normalizing the following year. In the meantime, insurance exposure to Hurricane Otis is capped (<1% per management), and there’s room to manage down recurring expenses to compensate. Even if we do see some pressure from funding and opex in 2024/2025, though, Banorte’s strong top-line momentum should be more than sufficient to keep earnings growth steady.
Well-Capitalized and Poised for More Shareholder Returns
For investors who prioritize consistent income and downside protection, Banorte offers plenty as well. Per Q3 results, asset quality is well under control; non-performing loans are still well below pre-COVID levels – despite the broader monetary tightening trend in recent years. Similarly, the bank’s cost of risk is low, highlighting the great job Banorte management has done in riding Mexico’s credit expansion wave without quality tradeoffs.
As we enter an easing cycle later this year, any financial stress should ease further, allowing Banorte to readjust its risk profile and potentially unlock more loan growth to mitigate interest margin headwinds elsewhere. Further boosting capital levels is Visa’s (V) recent acquisition of a 51% stake in Mexican card processor Prosa (Banorte has a ~20% stake) – at an upsized transaction valuation. While any one-off gain is likely small in the grand scheme of things, it does highlight the optionality within Banorte’s digital portfolio.
As things stand, management’s guidance is for CET1 to end 2023 on a positive note – even after incorporating the MXN15bn special dividend (paid out in October). Given the mid to long-term CET1 ratio target range is 12-13% (vs. ~16% in Q3; ~14% post-Q4 special dividend), and total capital is similarly above regulatory minimums by a wide margin, expect more distributions into 2024 as well. So while Banorte hasn’t changed its formal 50% recurring dividend payout policy, the prospect of more extraordinary dividends means the total yield should continue to run in the high-single-digits % through 2024/2025. Either way, Banorte stock offers a compelling mix of growth and income at current levels.
Riding the Mexican Momentum
Owning a bank into rate cuts isn’t ideal, but in the case of Banorte, there are quite a few mitigating factors. For one, the structural Mexican tailwinds that are here to stay, including a more formalized financial sector and increased ‘nearshoring’ opportunities in the coming years. Significantly reduced interest rate sensitivity, a result of a growing fixed-rate asset base, also helps Banorte protect its margins in the meantime. Either way, there’s a clear path to a strong top and bottom-line performance into 2024, particularly with an election catalyst on the horizon as well. A richer book valuation post-year-end rally is a small hurdle, but on earnings (~8x forward P/E) and yield (high-single-digits %), the investment case remains as compelling as ever.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.