WF - Woori Financial: Consider International Expansion And M&A

2024-01-02 17:00:00 ET

Summary

• WF aims to grow the profit contribution from its overseas banking businesses over time with a focus on specific Southeast Asian markets like Indonesia and Cambodia.
• Woori Financial could find it tough to execute on future M&A deals, due to constraints associated with deal pricing and capital adequacy.
• I make no changes to my existing Hold rating for WF following an evaluation of Woori Financial's foreign markets expansion plans and its inorganic growth prospects.

Elevator Pitch

Woori Financial Group ( WF ) [316140:KS] is still awarded a Hold investment rating.

Earlier, my October 17, 2023 article drew attention to Woori Financial's prospects for the second half of last year, and WF's purchase of a 1.2% equity interest in the company from Korea Deposit Insurance Corporation or KDIC.

I like WF's plans to expand its profit contribution from international markets, but I am less optimistic about the company's inorganic growth potential. These factors support my decision to maintain a Hold rating for WF.

Growing Earnings Contribution From Foreign Markets Is A Key Positive

WF has set a goal of having its banking business' Global Business sub-segment increase its income contribution as a proportion of total earnings from 15% for FY 2022 to 25% in the long run (or 2030 to be specific), as indicated at its most recent Q3 2023 results briefing .

At the company's third quarter earnings call, Woori Financial noted that it will "be selective and be concentrating" in "three areas" for its expansion plans outside of its home market, South Korea. As reported in The Korea Times , WF's focus is on growing the operations of its "three main entities in Southeast Asia, based in Indonesia, Vietnam and Cambodia", which generated 43% of the Global business sub-segment's FY 2022 net income.

Woori Financial's target is for its Cambodian and Indonesian banking businesses to become the five largest and 10 biggest banks in their local markets, respectively, as indicated in The Korea Herald's news article . WF plans to set aside $0.5 billion to be invested in its Southeast Asian banking operations for 1H 2024.

The company's non-banking businesses are also in the midst of expanding into foreign markets. For example, WF's financial leasing arm is proposing to venture into the Indian market in the current year.

The market assigns a hefty valuation discount to WF, and this might be attributable to Woori Financial's limited geographical diversification. Woori Financial and Mitsubishi UFJ Financial Group, Inc. ( MUFG ) currently trade at trailing P/B ratios of 0.35 times and 0.84 times (source: S&P Capital IQ ), respectively. One of the key reasons for MUFG's valuation premium is that this Japanese financial institution is geographically diversified with international markets contributing close to half of its earnings.

As such, it is likely that Woori Financial can trade at a higher valuation multiple in the future, assuming that the company's earnings contribution from international markets increases over time. On the flip side, it could be more difficult for WF to execute on its inorganic growth strategy as detailed in the subsequent section.

But M&A Might Be Challenging Due To Pricing And Capital Adequacy

According to financial data sourced from S&P Capital IQ , the market's consensus FY 2023-2027 operating revenue CAGR projection for Woori Financial is a modest +2.9%. Since consensus financial forecasts typically don't factor in potential acquisitions, it is reasonable to come to the conclusion that WF's organic growth outlook is unexciting. This means that it is necessary for Woori Financial to consider inorganic growth initiatives to boost its top line.

Woori Financial shared at its third quarter earnings briefing that it wants to "be more proactive in our M&A efforts", and stressed that "if there are good candidates, then we are going to go for the acquisition." It is clear that WF has the intention of being more aggressive when it comes to inorganic growth.

However, WF faces two key challenges relating to the company's M&A growth strategy.

The first challenge is pricing.

A November 20, 2023 Korea JoongAng Daily news report mentioned that Woori Financial withdrew from a potential M&A deal because of "cost" and "price conditions." It is never easy to find good acquisition targets that can be bought at attractive valuations. It doesn't help that WF's valuations are depressed (0.35 times trailing P/B, 3.5 times consensus forward P/E as per S&P Capital IQ data), and this suggests that this is difficult for Woori Financial to buy over other businesses at appealing valuation multiples (that are below its own valuation metrics) to make such transactions value-accretive.

The second challenge relates to capital adequacy.

Woori Financial's capital adequacy is the lowest among the major Korean financial institutions, and this places a limit on WF's financial capacity for acquisitions to some extent. WF's Common Equity Tier 1 capital or CET1 ratio was 12.1% as of September 30, 2023. The end-Q3 2023 CET1 ratios for KB Financial ( KB ), Shinhan Financial ( SHG ), and Hana Financial [086790:KS], were relatively better at 13.7% , 12.9% , and 12.7% , respectively.

WF's actual M&As could possibly fall short of the market expectations, as its capital adequacy is inferior to that of its key peers and there might be few acquisition targets that are up for sale at reasonable valuations.

Final Thoughts

Woori Financial stock is inexpensive, considering the 65% discount to net asset value and the low single-digit earnings multiple. But WF's undemanding valuations are fair, as the company will take time to grow its overseas markets income contribution to a meaningful level. Moreover, Woori Financial's inorganic growth ambitions might be constrained by the lack of attractively-priced assets and its lower-than-peer capital adequacy ratio. In conclusion, I deem a Hold rating for WF to be justified.

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