Dutch Discount Bin: ING

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The Dutch discount is the phenomenon of the comparatively low valuation of Netherlands traded stocks. However, the Dutch discount re-appeared in financial news because the main index lagged the broad European stock market over the past year. The reason for the current discount can be found in the underperformance of some individual stocks, as well as macro-economic factors. Some stocks affected by the market sentiment have shown solid profits, great international presence and are unjustifiably affected.

The undervalued stock
Today we will look at ING Groep NV (NYSE: ING). It is primarily a bank but also owns a substantial insurance business. ING had its share of difficulties during the 2008 financial crisis which resulted in a government bailout. Because of this support, the European commission has forced ING, among other things, to divest its insurance business. ING is on track to become more profitable and has set a target of 10% ROE for 2015, the year in which it will repay the final part of the government bail-out and resume dividend payments. The stock currently trades at about 7.5 times 2012 earnings and 50-55% of book value.

According to many analysts, the main cause of the low valuation is the fact that the restructuring of the business takes place during challenging and volatile market conditions. The European life insurance unit for example is expected to sell in this low interest rate market. The end of QE3 will be welcomed by ING shareholders and provides a floor under its stock price as rising interest rates increase the value of its life insurance business. Therefore, the upside potential is quite good. It is especially good when ING US (NYSE: VOYA) stock trades above $30.63.

The deal with ING U.S.
ING has brought its US pension and life insurance business to the NYSE under the name ING U.S. (to be changed to Voya Financial). The stock went public last May for $19.50 and has appreciated a lot since then. ING still has a 71% stake  in ING U.S. which will be reduced to 0% by 2016.

To me, it seems as if the market at first routinely valued ING U.S. like it valued its former parent ING. However, after a while, the market came around and discovered the hidden potential of ING U.S. and value behind the book value of $58.22 per share. The underlying earnings are good, but the bottom line is troubled by legacy products.

Peer review
It’s remarkable how the market currently values Aegon N.V. (NYSE: AEG), a Dutch life-insurance business that gets the vast majority of its earnings from its US operations. The US operations of Aegon and ING U.S. have much in common, so the fate of Aegon is relevant to ING. U.S. and vice versa.
Aegon currently trades at a rough TTM P/E of 7 , and a price-to-book ratio of 0.5 as of Q1 2013. The value of new business shows 86% year-on-year quarterly growth, mainly because of its retirement and aging products. And what’s even more important is that the company’s financial health is good enough to pay out only 30% of its earnings in dividends, providing a dividend yield of nearly 4%. The business Aegon operates in the US is very healthy but the discount on book value is especially heavy when compared to domestic insurance companies.

So when reviewing the valuation of Aegon versus ING U.S., the main source of the recent rise of ING U.S. stock price seems to be the removal of the undervaluation the market puts on European insurance companies.

But why the $30.63?
If ING manages to fully sell its remaining stake in ING U.S. for at least $30.63 a share, it won’t have any remaining debt after breaking up the leverage structure bank/insurance holdings are allowed to have. Thus, ING will return to its core-business, which is banking in Europe. A spin-off of the European insurance business rather than a forced sale becomes more likely when a sale is not necessary to repay the double leverage. As is well known, this is not a great time to sell insurance companies, due to low market interest rates. So for long-term ING stockholders it's better to spin the European insurance business off and have them decide what to do.

It is also good to know that the banking division doesn't need any more capital as it reached its internal Basel III core tier 1 capital target of 10% and now stands at 10.4%. Besides that great news, the mean analyst target of ING is $11.73, implying an upside of 25%. Some of those analysts state that the undervaluation of ING will probably disappear within the next few years.

Bottom line
ING has much potential that will finally be reflected in its stock price as the deadlines set to restructure its business move closer. It is so heavily undervalued that the stigma apparently affected the stock price of its US insurance business before it went public. With that behind us, we can look forward to a valuable bank that currently trades at a steep Dutch discount.

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Robbert Manders owns shares of ING Groep N.V. (ADR). The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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