I maintain my Neutral rating on Korea-listed financial services company Shinhan Financial Group Co., Ltd. (NYSE:SHG) [055550:KS]. While I have a negative view of the company’s recent fund raising, I expect a significant improvement to Shinhan Financial’s capital return to shareholders over time.
This is an update of my prior article on Shinhan Financial published on August 7, 2020. Shinhan Financial’s share price has increased by +8% from KRW30,700 as of August 6, 2020, to KRW33,250 as of November 19, 2020, since my last update. Shinhan Financial trades at 0.38 times P/B and 5.1 times consensus forward FY 2021 P/E, and it offers a consensus forward FY 2021 dividend yield of 5.4%.
Shinhan Financial’s recent fund raising is unfavorable, given the dilution to future earnings per share and the significant discount to book value implied by the new share issuance price. On the positive side of things, Shinhan Financial has plans to improve the company’s capital return to shareholders, which include the initiation of quarterly dividends (as opposed to paying out dividends once per year) and an increase in the company’s dividend payout ratio to 30% (from 25% in FY 2019).
Readers have the option of trading in Shinhan Financial shares as ADRs on the New York Stock Exchange with the ticker SHG, or on the Korea Exchange with the ticker 055550:KS. For those shares listed as ADRs on the New York Stock Exchange, average daily trading value for the past three months is decent at $3 million, but lower than that for the Korea-listed shares.
For those shares listed in Korea, there are limited risks associated with buying or selling the shares in terms of trade execution, given that the Korea Exchange is one of the major stock exchanges that is internationally recognized, and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $70 million, and market capitalization is above $15.9 billion, which is comparable to the majority of stocks traded on the US stock exchanges.
Institutional investors who own Shinhan Financial shares listed in Korea include BlackRock Institutional Trust Company, The Vanguard Group, RBC Global Asset Management, Lazard Asset Management, and Dimensional Fund Advisors, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers or Fidelity, or international brokers with Asian coverage like Hong Kong’s Monex Boom Securities and Singapore’s OCBC Securities.
On September 4, 2020, Shinhan Financial announced that the company is raising KRW1.16 trillion in fresh funds by issuing 39,130,000 new shares at KRW29,600 per share to special purpose vehicles advised by private equity firms Baring Private Equity Asia and Affinity Equity Partners.
Shinhan Financial’s recent fund raising is unfavorable for a number of reasons.
Firstly, the new share issuance will expand the number of outstanding shares of Shinhan Financial by approximately 8%, which implies a significant dilution to the company’s future earnings per share.
Secondly, Shinhan Financial is issuing new shares at a significant discount to its book value (0.36 times P/B), despite the fact that the share issuance price of KRW29,600 only represented a -1.3% discount to the company’s share price of KRW30,000 as of September 3, 2020. This sends a negative signal about how the company thinks of the stock’s current valuations.
Thirdly, the rationale for the company’s recent fund raising is not very convincing, considering the extent of the dilution to the existing share base and the significant discount to book value implied by the new share issuance price. According to a September 13, 2020, news article by The Korea Herald, Shinhan Financial’s main reason for the recent fund raising was to increase its Common Equity Tier 1 or CET-1 ratio from 11.4% as of June 30, 2020, to 12.0%. However, Shinhan Financial’s CET-1 ratio is relatively healthy even at 11.4%, which is comparable to most of the other financial institutions in the Asia Pacific based on a recent September 2020 report by PIMCO.
On the flip side, the special purpose vehicles advised by the two private equity firms have become the second-largest shareholder of Shinhan Financial, and they are not allowed to sell the new shares issued for a period of two years. With the oversight of the two private equity firms and additional capital buffer, Shinhan Financial is better positioned to pursue future growth opportunities in the future. There are media reports suggesting that Shinhan Financial is “considering creating or acquiring a new digital non-life insurance firm.”
But there is no guarantee that Shinhan Financial’s future investments, be it organic or inorganic, will create value for shareholders. Furthermore, Shinhan Financial could have probably considered a rights issue for existing shareholders, as an alternative to issuing shares to new investors.
Capital Return To Shareholders
Shinhan Financial offers relatively attractive consensus forward FY 2020 and FY 2021 dividend yields of 5.1% and 5.4%, respectively. There are signs that Shinhan Financial has plans to improve the company’s capital return to shareholders, which will be a major positive.
At the company’s 3Q 2020 earnings call on October 27, 2020, Shinhan Financial noted that “we will implement diverse shareholder return measures, including quarterly dividends” as the company has achieved its target 12% CET-1 ratio following the recent share issuance. The company has only paid out dividends once per year historically.
Shinhan Financial also guided at the recent 3Q 2020 earnings call that “we expect to pay out at least the previous year’s levels dividend per share” if “the CET-1 ratio as of September end is maintained and if the ordinary income at the end of the year is realized at a similar level to the previous year.” In contrast, sell-side analysts see Shinhan Financial’s full-year dividends decreasing by -6% from KRW1,850 in FY 2019 to KRW1,697 in FY 2020, prior to increasing by +8% to KRW1,804 in FY 2021. This implies that Shinhan Financial’s actual dividend payout for FY 2020 could be higher than what market consensus is expecting.
There could also be other improvements to Shinhan Financial’s capital return policy. A September 7, 2020, article published on Business Korea referencing a sell-side research report suggested that Shinhan Financial wishes to increase the company’s dividend payout ratio from 25% in FY 2019 to 30% and above and also execute on more share repurchases and share cancellations in the medium term.
3Q 2020 Results And Outlook For FY 2021
Shinhan Financial announced the company’s 3Q 2020 financial results on October 27, 2020, and its financial performance in the third quarter of this year exceeded market expectations.
The company’s net profit attributable to shareholders expanded by +17% YoY and +31% QoQ to KRW1,144.7 billion in 3Q 2020. Shinhan Financial’s loans increased by +2.1% QoQ from KRW237.2 trillion in 2Q 2020 to KRW242.3 trillion in 3Q 2020. On a year-to-date basis, its loans grew by +9.8% YoY as of September 30, 2020. Shinhan Financial’s net interest margin declined marginally by -3 basis points QoQ from 1.81% in 2Q 2020 to 1.78% in 3Q 2020.
Shinhan Financial’s asset quality also continued to improve in the third quarter of the year. Its NPL (Non-Performing Loans) ratio decreased by -2 basis points QoQ and -6 basis points YoY to 0.54% in 3Q 2020. The delinquency ratios for Shinhan Financial’s banking and credit card businesses also declined by -4 basis points QoQ and -2 basis points QoQ to 0.26% and 1.24%, respectively in the third quarter of this year.
Looking ahead, Shinhan Financial has guided at the company’s 3Q 2020 results briefing on October 27, 2020, that it can maintain a sustainable quarterly recurring income of KRW1 trillion going forward. If Shinhan Financial does achieve this, the company could possibly beat market consensus’ full-year earnings estimates of KRW3.38 trillion and KRW3.37 trillion for FY 2020 and FY 2021, respectively.
Valuation And Dividends
Shinhan Financial is valued by the market at 0.38 times P/B based on its share price of KRW33,250 as of November 19, 2020. As a comparison, its five-year and 10-year mean P/B multiples were 0.60 times and 0.69 times, respectively.
The stock also trades at 5.0 times consensus forward FY 2020 and 5.1 times consensus forward FY 2021 P/E. In contrast, Shinhan Financial’s five-year and 10-year average consensus forward next twelve months’ P/E multiples were 7.1 times and 7.9 times, respectively.
The key risk factors for Shinhan Financial are future corporate actions that do not create value for the company and minority shareholders, capital return to shareholders falling short of market expectations, and weaker-than-expected earnings growth going forward.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.