Following the article 'How does a bank work
', we present DBS, a Singaporean bank which activities are mainly concentrated in the city-state (two thirds of its revenue), China (a quarter of its revenue), and to a lesser extent in emerging economies in the region (such as India and Indonesia).
DBS is know of its expertise in e-banking - a business model with a cost structure that’s more attractive than the traditional brick and mortar business model - and generates a pre-tax margin of 40%, a performance that clearly exceeds that of the best American and European banks (with pre-tax margins of respectively 30% and 20%).
The marketing efforts made in the wealth management segment - a very profitable activity with high margins and unrelated to interest rates - and the eased legal restrictions compared to those of Western banks contribute to this record level profitability.
The bank has been growing steadily (since 2008, the profit increases with a 7,2% annualized average), and is well-capitalized and well-funded. Its leverage remains reasonable (less than eight times its equity), the defaults within the loans portfolio are kept under control (less than 2%), and its Tier 1 capital is around 15%.
For the anecdote’s sake, and although it’s an industry standard now, the author expresses certain reservations when it comes to the relevance of this so-called Tier 1 capital : in 2015, while they found themselves once again to be in an insolvency situation, the Greek banks were - on paper - the most well-capitalized banks in Europe!
At DBS, the profitability of the equity oscillates around 10% for the most recent cycle, an honorable but certainly not remarkable performance - the issue of being too well-capitalized is that it lowers the profitability at the same time.
This illustrates clearly the eternal dilemma of the banking business: preventing the risk and sacrificing the profitability, or deploying more capital but thus exposing the bank to the first crisis shake that comes along.
The low interest rates (the main interest rate in Singapore is 1%) aren’t good for business either. However, just like the projections in Europe and the United States, people expect a recovery of the inflation and an increase of the corresponding interest rates (eagerly awaited by the banks).
The CEO of DBS expects by the way that a 1% increase of the leading interest rate will lead to a simultaneous increase of the profitability of the equity of one percent.
On average, the bank distributes between on third and half of its profits in dividends. In this regard, and under similar management and market conditions (meaning without an interest rate increase), we can thus project en equity per share of around $20 in 2020.
A stable profitability of the equity would allow for a $2 profit per share. At currently $29, the ordinary DBS share trades thus at a little less than fifteen times its profit adjusted for any kind of growth projection - a scenario that is more conservative than the projections of the analysts who follow the institution.
Taking into account the usual reservations of when you invest in the banking sector, a continuous growth - which is very likely given the dynamics in the region - and/or an increase of the interest rates will have a positive impact on the valuation. A deterioration of the market conditions in Asia would on the other be an immediate sell signal.
DBS is a new position in the 4-Traders Asian portfolio
Translated from the original article
Article published on 05/16/2018 | 14:53