winhorse
DBS Group (OTCPK:DBSDF) (OTCPK:DBSDY) hasn’t had perfect quarterly reports since my last update, but the underlying performance of the bank has been better than the basically flattish performance of the share price would suggest. It’s understandable that investors are worried about the impact of higher rates on Asian economies (and borrowers) and the risk that turmoil in the Chinese property sector spreads, but that worry seems to be excessive relative to the company’s credit quality and earnings power over the next year or two.
DBS Group is always going to be a higher-risk investment than a bank like Bank of America (BAC) given the company’s exposure to multiple economies, including more volatile markets like China, India, and Indonesia, but I wouldn’t ignore the strong returns on capital that this bank has generated over full cycles, nor the efforts that the company has invested toward establishing itself as a significant digital banking presence in multiple growth markets. I believe the shares are at least 10% undervalued today and priced for a long-term total annualized return in the low-to-mid-teens.
Fee Income And Loan Demand Claw Back A Bit Of DBS’s Rate Leverage
DBS Group is the most asset-sensitive of the Singaporean banks and quite sensitive on an absolute basis, with a 100bp move in U.S. rates expected to drive roughly 20% growth in net interest income. That rate leverage has come on even faster than analysts, or bank management itself, expected to see, but the benefits of that rate leverage have been tempered somewhat by challenges in other parts of the business.
Revenue rose 6% year over year and 1% quarter over quarter in the second quarter, missing expectations by about 1%. Net interest income was strong, rising 17% yoy and 12% qoq, and beat expectations by 2%, as net interest margin improvement of 13bp yoy (to 1.58%) exceeded expectations. Earning asset growth (up 7% yoy and 5% qoq) was a bit sluggish, though.
Non-interest income declined 11% yoy and 14% qoq, missing by 6%, with fee-based income down 12% yoy and 14% qoq. Card fee income growth has remained healthy (up 23% yoy and 9% qoq), but DBS Group has been hit hard by a decline in wealth management fees (down 21% yoy and 17% qoq) related to market volatility.
Operating expenses rose 7% yoy and 1% qoq, exceeding expectations by about 2%, as management continues to invest in the long-term growth of the bank (including ongoing investments into digital capabilities and brand-building in growth markets).
Pre-provision profits rose 4% yoy and 1% qoq, missing by 4%, and while I do believe DBS Group is undervalued and underappreciated, the reality is that three straight pre-provision misses don’t help the bull argument. Attributable profits rose 7% yoy and 1% qoq and beat expectations by 2%. In the “battle” of attributable profits and pre-provision profits, I typically pay more attention to the latter, as credit costs are more volatile on a quarter-to-quarter basis and I believe DBS is at a point in the cycle where provisioning will be less of a source of sustainable upside.
Lending Is Not Seeing As Much Strength As I’d Like
DBS Group posted 7% yoy and 1% qoq loan growth in the second quarter (on a constant currency basis), and this is a little light of what I’d wanted to see. Loans to manufacturing customers are growing strongly, up 18% yoy and 22% qoq as businesses seek loans to fund working capital and capacity expansion, but housing and “general commerce” are more sluggish.
The flat sequential performance in housing lending isn’t too surprising given ongoing efforts in Singapore to keep a lid on the housing market, but the flat yoy performance in general commerce lending (up 4% qoq) is more disappointing given overall economic conditions. Building and construction, up 13% yoy and 4% qoq, is stronger though.
I don’t expect a particularly quick or sharp turnaround in DBS Group’s primary housing lending markets, but I do see room for general commercial lending to accelerate further and for manufacturing lending to remain strong. The situation in China is well worth monitoring though, as the property sector there has come under real strain. DBS Group management has sized their property developer loan exposure at around S$2B, or around 0.5% of all loans, but that lending is concentrated among the largest, most liquid developers.
I’m likewise a bit concerned about what even higher rates could do to loan demand in the coming quarters. Management has called out a risk of higher rates pushing its major served economies into a slowdown, and I don’t think that’s a trivial risk, particularly with many commodity prices starting to ease.
That said, deposits continue to grow at DBS Group (usually a good metric for the underlying health of its customer base), and non-performing loans have flattened out. I don’t expect lower provisioning to be a major source of upside from here on (provisioning should normalize), but the company came out of this latest downturn in better shape than most analysts expected at the outset of the pandemic.
The Outlook
Given the varied economies that DBS Group serves, there’s always something to worry about from a macro viewpoint if you take the time to look. I don’t mean that as a flippant dismissal of macro risks for the bank, but my point is rather that I don’t see anything particularly new or concerning and I think DBS Group’s track record over multiple cycles should serve as at least some evidence that they are up to the challenge of managing these risks.
I do expect DBS Group to see some further improvement in net interest margin, but I think the leverage from rate sensitivity is going to slow from here. I likewise see less benefit from better credit costs. That leaves DBS Group more sensitive to underlying loan growth as a primary driver, and this is where the bank will need to show that it can continue to gain share, not just in established markets like Singapore and Hong Kong, but growth markets like China, India, and Indonesia as well.
Factoring in the results DBS Group has posted since my last update, my modeling changes aren’t all that large – my FY’22 core earnings estimate goes up about 3% and my FY’23 estimate goes up about 5%. Longer term, I’m still expecting core earnings to grow at a high single-digit rate over the next five years and a mid-to-high single-digit rate over the next decade.
The Bottom Line
Between discounted core earnings and an ROE-driven P/BV approach, I believe DBS Group shares are undervalued by at least 10% today and priced for a long-term annualized return in the low-to-mid-teens. While that’s not a bad return from a well-run bank that gives investors good exposure to multiple markets in Asia, I do have to note that there are many U.S. banks that offer similar upside today with less macro risk (or at least a less complex mosaic of risks). So I do still like and recommend DBS Group, but on a relative risk/reward basis it is maybe not as compelling compared to U.S. banks as it has been at some prior points in time.
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