WF - Woori Financial: Watch Capital Adequacy And Capital Allocation

2023-06-01 10:25:51 ET

Summary

• The CET1 ratio for Woori Financial has increased YoY and QoQ in the recent quarter, but WF's CET1 ratio is still the lowest among the major Korean financial institutions.
• Woori Financial's future capital allocation initiatives like M&A and capital return might be affected by the need for WF to have a reasonably high CET1 ratio to meet regulatory requirements.
• I continue to assign a Hold rating to WF stock based on my assessment of Woori Financial's capital adequacy metrics and capital allocation plans.

Elevator Pitch

Woori Financial Group Inc.'s ( WF ) [316140:KS] stock continues to warrant a Hold investment rating. I commented on the recent corporate and industry developments for WF in my earlier March 21, 2023 write-up .

I turn my attention to Woori Financial's capital adequacy metrics and the company's capital allocation priorities in the current article. While I have a positive opinion of the improvement in WF's CET1 (Common Equity Tier 1) ratio, I don't think that Woori Financial's current capital adequacy is good enough to support its future capital allocation plans. Therefore, I have a Neutral view and Hold rating for Woori Financial.

Capital Adequacy

Woori Financial's key capital adequacy metric, the CET1 ratio, improved from 11.3% in the first quarter of 2022 and 11.6% in Q4 2022 to 12.1% for Q1 2023, as indicated in its quarterly earnings presentation .

On the positive side of things, it is encouraging to see WF's CET1 ratio rising on both a YoY and a QoQ basis. Woori Financial has also met the 12.0% CET1 target that the company outlined earlier in February 2023.

More significantly, WF guided at its Q1 2023 earnings briefing that it "plans to further improve capital adequacy through solid financial performance." This implies that Woori Financial is of the view that its CETI ratio could potentially rise further in the quarters ahead.

On the negative side of things, Woori Financial's CET1 ratio remains the lowest among the "Big 4" financial institutions in South Korea. As a comparison, Shinhan Financial Group's ( SHG ) [055550:KS], Hana Financial Group's [086790:KS], KB Financial Group Inc.'s ( KB ) [105560:KS] CET1 metrics were 12.5%, 12.8%, and 13.7%, respectively for Q1 2023 based on the individual companies' disclosures.

Also, the improvement in WF's CET1 ratio in the recent quarter might have come at the expense of growth. At its Q1 2023 results call, Woori Financial highlighted that "asset quality management efforts" was a key factor driving its CET1 ratio higher for Q1 2023. But WF's focus on "asset quality management" might explain why Woori Financial's total loans contracted by -0.8% YoY in the first quarter of this year.

In summary, there are positive and negative read-throughs from Woori Financial's updated CET1 metric. On one hand, WF's CETI ratio for the most recent quarter was better than what it achieved for prior quarters, and the company's guidance points to a further improvement in its CET1 ratio going forward. On the other hand, Woori Financial's CET1 ratio was still inferior to that of its key peers, and its near-term loan growth might remain subdued as WF places a strong emphasis on achieving a healthy CET1 metric.

Capital Allocation

The key capital allocation-related catalysts for Woori Financial are a higher level of share repurchases and dividends, and mergers & acquisitions or M&A to diversify away from its core banking business. But WF's actual capital allocation actions might disappoint the market, considering that its CET1 ratio is lower than that of peers (as detailed in the preceding section) and recent unfavorable regulatory developments. In my March 2023 update for WF, I specifically highlighted that "Korean banks in general might be hit with higher minimum capital requirements in the short term" as per recent news flow.

At its recent first quarter results call (full Q&A transcript sourced from S&P Capital IQ ), Woori Financial noted that the regulators are currently considering "stress test capital buffers, countercyclical capital buffers and other measures" to "strengthen capital adequacy" for Korean financial services companies. WF acknowledged at the most recent quarterly results briefing that it will need to "revisit" its shareholder capital return plans at the end of the year after the new regulatory changes relating to capital adequacy are finalized.

This suggests that there is a risk of WF distributing less dividends and executing on a lower amount of buybacks than what the market is expecting. Woori Financial's existing guidance is to allocate 30% of its earnings to share buybacks and dividend payouts each year assuming its CET1 ratio hits 12% or higher. But WF's recent management commentary implies that there is no certainty that the company will be able to meet its guidance on shareholder capital return going forward, taking into consideration regulatory changes on capital requirements for Korean financial companies.

Separately, there is a need for Woori Financial to diversify beyond its core banking business in a more aggressive manner, but WF's current CET1 ratio might not be sufficiently high to allow it to allocate more capital to M&A.

As disclosed in its first quarter results presentation, the core banking business accounted for 94% of Woori Financial's Q1 2023 net profit and 80% of WF's total assets as of March 31, 2023. WF's most recent M&A deal was the purchase of a controlling inter est in a venture capital firm known as Daol Investment in February this year as part of its plans to grow earnings contribution from non-banking businesses. However, if WF has to increase its CET1 ratio to a higher level demanded by regulatory agencies in the future, this will naturally translates into lower level of capital available for M&A activities.

Concluding Thoughts

There are catalysts relating to capital allocation such as acquisitions and shareholder capital return that might help to re-rate Woori Financial's shares. But WF's key capital adequacy ratio, the CET1 ratio, is still lower than that of its peers, and this could make it difficult for Woori Financial to allocate a significant amount of capital to buybacks or M&A. Given the uncertainty over the company's ability to realize capital allocation-related catalysts, I choose to retain a Hold rating for Woori Financial.

For further details see: