NMR - Nomura Holdings: ROE Improvement Is Still A Work-In-Progress

2023-09-05 07:32:55 ET

Summary

• Nomura Holdings' Q1 FY 2024 ROE was low at 2.9%, which is way below the company's FY 2025 ROE target at the 8%-10% level.
• NMR is valued by the market at an undemanding 0.55 times P/B, which is reasonable considering that the company has found it tough to achieve a higher ROE.
• I stick to my existing Hold rating for Nomura; I will only consider upgrading NMR's rating to a Buy if there are signs of a significant improvement in its ROE.

Elevator Pitch

Nomura Holdings, Inc. (NMR) [8604:JP] stock is awarded a Hold investment rating. My prior August 17, 2022, write-up for Nomura Holdings was focused on reviewing the company's Q1 FY 2023 (April 1, 2022, to March 30, 2023) financial performance and assessing its fiscal 2025 ROE goal in the 8%-10% range.

For this latest update, I track Nomura Holdings' progress in moving closer to its FY 2025 ROE target. My analysis finds that NMR has struggled to improve its ROE, and more time is needed for the company's ROE expansion, which justifies a valuation discount for the stock. Therefore, I have chosen to maintain a Hold rating for Nomura Holdings.

Analysts Have Turned More Bearish On NMR's Prospects

In the past five months, the FY 2024 and FY 2025 consensus earnings per share or EPS estimates (in local currency terms) for Nomura Holdings have been lowered by -6% and -18% to JPY53.78 and JPY50.76, respectively, as per S&P Capital IQ consensus data.

I think that the substantial downward revision in Nomura Holdings' bottom line forecasts is justified, taking into account the fact that NMR doesn't seem to have made much headway in improving its ROE.

As indicated in the company's 2023 Investor Day presentation slides , Nomura Holdings' ROE declined from 5.1% in fiscal 2022 to 3.1% for FY 2023. NMR revealed in its Q1 FY 2024 earnings presentation that the company's ROE had decreased to an even lower 2.9% in the recent quarter.

With my earlier mid-August 2022 update, I had specifically noted that a higher proportion of recurring revenue, lower expenses, and a larger percentage of shareholder capital returned to shareholders are the main drivers of ROE improvement for Nomura Holdings. In the subsequent sections of this article, I evaluate whether NMR has done sufficiently well in these key areas.

Recurring Revenue

NMR's pace of recurring revenue expansion isn't as fast as what investors would have hoped for.

Recurring revenue for Nomura Holdings' Retail business segment only increased slightly by +2% QoQ from JPY33.5 billion in the fourth quarter of fiscal 2023 to JPY34.2 billion for Q1 FY 2024. At its recent first quarter earnings briefing , NMR admitted that "recurring revenue asset net inflows slowed as some investors sold out to take profits amid the rally."

It is also worrying that NMR has lowered the company's expectations for recurring revenue growth in the intermediate term. Between May last year (2022 Investor Day) and May this year (2023 Investor Day), Nomura Holdings reduced its net inflows for FY 2025 recurring revenue assets and total recurring revenue assets targets by -43% and -16% to JPY800 billion and JPY21.6 trillion, respectively.

Nomura Holdings explained at its 2023 Investor Day webcast that it had "factored in a stagnation and decline in voluntary transactions, particularly for customers with non face-to-face needs" in revising its targets relating to recurring revenue downwards. It isn't a major surprise that NMR is finding it tough to cross-sell recurring advisory services to its customers in a weak economic environment.

Expense Optimization

It is a difficult balancing act for Nomura Holdings to achieve both top line growth and profit margin expansion.

At its 2023 Investor Day, NMR mentioned that it aims to increase the number of employees for its Global Markets business by +5% in areas such as "Sales, Trading & Structuring" to "deepen scale and address product & coverage gaps." Also, expenses relating to compensation and benefits went up by a significant +11% YoY from JPY143 billion for Q1 FY 2023 to JPY159 billion in Q1 FY 2024, which Nomura Holdings attributed to "inflation overseas and wage rises in Japan" at its first quarter results call.

Therefore, it might be challenging for Nomura Holdings to lower its cost-to-income metric from 91% in FY 2023 to 80% for FY 2025 as per the company's financial targets outlined at its 2023 Investor Day.

Capital Return

Nomura Holdings highlighted its goal of achieving a dividend payout ratio in excess of 40% and a total shareholder capital return (including share repurchases) ratio of over 50% at the company's most recent Investor Day held in May this year.

There are signs suggesting that NMR might potentially fall short of the market's investors pertaining to capital return.

At the company's recent Q1 FY 2024 earnings briefing, a sell-side analyst from Daiwa Securities questioned whether Nomura Holdings' interim 1H FY 2024 dividend might be affected by the estimated JPY13 billion mark-to-market loss associated with NMR's investment in American Century Investments. In response, Nomura Holdings noted that it "will wait until the second quarter has finished and decide (on the dividend) taking into account various factors including ACI (American Century Investments)." If the 40% dividend payout ratio is based on Nomura Holdings' bottom line net of ACI-related losses, the company's actual dividend distributions for 1H FY 2024 could be lower than what investors are expecting.

On the other hand, Nomura Holdings acknowledged at its 2023 Investor Day in May that "it will probably be difficult to do it (share repurchases) at the same pace that we did in the past" and suggested that share buybacks "will normalize to a certain extent." NMR also mentioned at the Investor Day in May this year that "it will probably be appropriate to return that to shareholders", assuming "there are no such (inorganic growth) opportunities." NMR's management comments imply that the company is likely to prioritize inorganic growth investments over capital return, and that it is most probably going to execute on fewer share buybacks in the near term than what the company did previously.

Concluding Thoughts

NMR is now trading at a -45% discount to its book value per share as per S&P Capital IQ valuation data. I deem this to be fair, as I think that it will take a longer than expected period of time for Nomura Holdings to meet its 8%-10% ROE target. Various metrics highlighted in this article indicate that it will be very challenging for NMR to improve its ROE to 8% or better by FY 2025. As such, I make no changes to my existing Hold rating for Nomura Holdings.

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