SHG - Shinhan Financial: Mixed Prospects Fair Valuation

2023-10-06 03:59:15 ET

Summary

• Shinhan Financial's outlook is mixed, considering various factors like capital adequacy, capital return, digitalization, and competitive dynamics.
• The Company is now trading at 0.93 times price-to-earnings growth or PEG, which indicates that the stock is valued fairly by the market.
• My rating for SHG stays as a Hold, following an analysis of its prospects and valuations.

Elevator Pitch

My Hold investment rating for Shinhan Financial Group Co., Ltd. ( SHG ) [055550:KS] remains unchanged.

I reviewed Shinhan Financial's Q2 2023 financial performance and analyzed the company's dividend distributions with my earlier write-up published on July 28 this year.

In my current article, I write about SHG's capital adequacy, share repurchases, digital-related investments, competition from new entrants, and its valuations. I come to the conclusion that Shinhan Financial's prospects are mixed and the stock is fairly valued. Therefore, I have left my Hold rating for SHG intact.

Focus On Capital Adequacy Might Come At The Expense Of Share Repurchases

According to The Banker's Top 1,000 World Banks 2023 ranking cited in a late-August news article published by The Korea Economic Daily , Shinhan Financial boasts the second highest level of Tier-1 capital among Korean financial institutions. SHG's capital adequacy was only inferior to that of its peer KB Financial ( KB ) if one only considers South Korea's banks in this ranking.

Shinhan Financial also recently revised its Common Equity Tier 1 or CET1 goal upwards by +100 basis points from 12% to 13%, when it communicated with analysts and investors at its most recent Q2 2023 results call .

The above suggests that SHG is placing a significant emphasis on capital adequacy, and it is natural to be concerned that the company could potentially pull back on share repurchases going forward.

As indicated in its corporate presentation slides , Shinhan Financial's CET1 ratio improved by +0.27 percentage points QoQ from 12.68% as of March 31, 2023 to 12.95% at the end of the second quarter. Notably, SHG's CET1 ratio took a -5 basis points hit from share buybacks and treasury share cancellation in the recent quarter. This means that Shinhan Financial might have already achieved a CET1 metric of 13% assuming that it didn't buy back and cancel any shares for Q2 2023.

It is also worth paying attention to the fact that SHG's Q3 2023 share repurchase guidance of KRW100 billion was reasonable, but this is much lower than the KRW150 billion of quarterly buybacks the company executed on for both Q1 2023 and Q2 2023.

In summary, it is encouraging to see Shinhan Financial set a higher CET1 ratio target, but it is a worry that SHG's future quarterly share buybacks could continue to decline with the company's focus on capital adequacy.

Increased Investments Could Be Needed For SHG To Stay Competitive

At the company's second quarter earnings briefing, Shinhan Financial stressed that it "will make the most effort to strengthen digital capabilities to boost fundamental financial competitiveness." SHG's recent management commentary is aligned with the company's latest actions. Local media publication The Korea Times reported in August 2023 that SHG rolled out the "1st group-wide data platform in (the Korean) banking industry" with expectations that its "customer-oriented digital banking services will accelerate" with this move.

SHG reported a profit contribution of KRW20.8 billion (about 1% of its bottom line) for the company's digital businesses in the first half of 2023. But Shinhan Financial noted in its corporate presentation slides that "increased digital and ICT (Information And Communications Technology) capital investments" drove its General & Administrative costs up by +9% YoY for 1H 2023. As such, it might take a longer period of time for Shinhan Financial to fully harvest the value of its digital investments.

More importantly, Shinhan Financial's investments in digital initiatives might just allow the company to remain competitive, rather than providing it with a major competitive advantage over its rivals. This is because new players are expected to venture into the Korean banking market, and give SHG and other incumbents a run for their monies.

In July this year, Bloomberg reported that South Korea's "financial regulator will allow financial firms to apply for nationwide commercial bank licenses", which is "the first time it's doing so since 1992." Based on a recent October 4, 2023 commentary piece published in industry publication International Banker , Dageu Bank is expected to be the "first new commercial bank (for Korea) in 31 years." It will be fair to assume that Shinhan Financial will be facing greater competition going forward, which increase the need for further investments in areas such as digitalization to stay competitive.

In my view, I like SHG's digitalization initiatives, but I am concerned that the company will have to sacrifice its profitability to be successful in competing with existing and new rivals.

Shinhan Financial's Valuations Are Fair

The market values Shinhan Financial at a consensus forward next twelve months' normalized P/E ratio of 4.1 times (source: S&P Capital IQ ). Although the stock's forward P/E multiple appears be cheap on an absolute basis, SHG's consensus forward fiscal 2023-2024 normalized EPS expansion estimate of +4.4% isn't particularly impressive.

This means that SHG's PEG or Price-To-Earnings Growth multiple is 0.93 times, or close to 1 times PEG metric indicative of fair valuation.

Concluding Thoughts

I continue to have a Hold rating awarded to Shinhan Financial. After reviewing SHG's key valuation metrics and the factors influencing the company's outlook, I decided that a Hold for the stock is appropriate.

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