WF - Woori Financial: Recent Developments Send Mixed Signals (Rating Downgrade)

2023-03-21 11:58:30 ET

Summary

• Woori Financial Group Inc. could potentially face headwinds such as tighter capital requirements and the threat from new entrants judging by recent news flow.
• But Woori Financial has sent a clear message that it is committed to returning more capital to shareholders with its new 30% total shareholder capital return goal.
• I rate Woori Financial Group shares as a Hold, in view of the mixed signals emerging from recent industry and corporate developments.

Elevator Pitch

I am downgrading my rating for Woori Financial Group Inc. ( WF ) [316140:KS] shares from a Buy previously to a Hold now.

Earlier, I upgraded WF's investment rating to a Buy on the basis that its shares were undervalued with my previous update for the company published on October 27, 2022.

With my latest write-up, I find that Woori Financial Group's recent share price correction is justified, and determine that a Hold rating is more appropriate for WF's shares now. A review of recent policy news flow leads to the conclusion that Korean banks in general might be hit with higher minimum capital requirements in the short term and tougher competition in the long run, and this is bad news for Woori Financial. Separately, while Woori Financial has laid out its plans for long-term shareholder capital return, recent regulatory developments might compel WF to defer its plans for increased shareholder capital return in the near term.

The above-mentioned factors explain my decision to lower my rating for Woori Financial to a Hold; but WF isn't a Sell considering its depressed valuations.

Policy Headwinds For South Korean Banks

Woori Financial Group's share price initially rose by +34% from $24.64 at the time of the publication of my prior article in late October last year to a three-month high of $32.96 on January 30, 2023. But the company's shares eventually pulled back significantly by -23% to close at $25.36 at the end of the March 20, 2023 trading day.

The sharp pull back in Woori Financial Group's stock price in the last two months is mainly attributable to policy headwinds for the Korean banking industry.

A February 28, 2023 Korea JoongAng Daily news article noted the regulatory authorities in South Korea want to "review methods to intensify competition in the (Korean) banking industry, like the introduction of challenger banks." Separately, The Korea Times published an article on March 16, 2023 highlighting that South Korea's Financial Services Commission plans to "strengthen the capital buffer requirement on (Korean) banks from Q2 or Q3" of the current year.

In my November 9, 2020 initiation article for Woori Financial, I have already stressed that WF has lots of work to do with respect to "diversification into non-banking businesses, as the banking business still contributes most of Woori Financial's earnings." Two years later, Woori Financial is a very much focused on its core banking business with limited progress made in terms of diversification efforts.

As indicated in its Q4 2022 earnings presentation slides , Woori Financial's banking business arm, Woori Bank, contributed 92% of the company's bottom line for full-year fiscal 2022. This means that Woori Financial could be badly affected by recent negative regulatory developments relating to the Korean banking sector referred to above.

Woori Financial Group's Shareholder Capital Return Plans

WF formally introduced the company's shareholder capital return strategy for the medium to long term at its Q4 2022 results briefing in early February 2023. Specifically, Woori Financial is targeting to distribute at least 30% of its excess capital to shareholders in the future, which will comprise of dividends (26%-30% payout ratio) and share repurchases (between 0% and 4% of shares outstanding).

With regards to dividends, Woori Financial Group's dividend payout ratio went up from 19.9% in FY 2020 to 25.3% in FY 2021 before further improving to 26.0% for FY 2022. In absolute terms, WF's dividend per share increased by +26% from KRW900 for FY 2021 to KRW1,130 in FY 2022. Woori Financial also noted at its most recent quarterly earnings call in February this year that the company is also considering a switch from semi-annual dividend payments to quarterly dividend pay-outs.

In terms of share repurchases, WF has plans to buy back and cancel around 4% of its outstanding shares in the second half of this year. Woori Financial also mentioned at its Q4 2022 investor call that it is "trying to increase the amount of share buybacks," assuming that it has "more capital room," and stressed that it will do its best to have "an appropriate balance" between share repurchases and dividends. Woori Financial is valued by the market a 70% discount to its tangible book value and a 2.4 times consensus forward next twelve months' normalized P/E (source: S&P Capital IQ ) now, so share repurchases are likely to be very accretive at current price levels for WF.

Looking ahead, as Woori Financial returns a greater proportion of its earnings and free cash flow to the company's shareholders going forward, the stock's valuation multiples should expand over time. This is because a higher level of shareholder capital return will increase WF's future ROEs (shrinkage of the shareholder equity base), and narrow the valuation discount assigned to Korean banking companies (perceived to be less shareholder friendly with a preference for hoarding cash).

However, expectations of a substantial increase in capital distributed to shareholders for Woori Financial in the short term need to be toned down. In the preceding section, I have already discussed about a potential increase in minimum capital requirements for Korean banks. Also, recent troubles relating to Credit Suisse Group AG ( CS ) and Silicon Valley Bank (SIVB) are likely to give Korean financial regulators reason to further tighten capital requirements, while Woori Financial and its peers are also likely to take a more cautious stance and retain more capital in this uncertain banking environment.

Closing Thoughts

A Hold is an appropriate investment rating for Woori Financial. Woori Financial Group Inc. shares are cheap, but this is justified based on policy headwinds and a potential delay in the roll-out of more aggressive capital return plans for the company.

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