2023-11-10 18:24:01 ET
Summary
- USB Group AG gets a hold rating, in line with the consensus from SA analysts and quant system.
- Some positives are YoY revenue growth, net client inflows, proven outperformance of the S&P500, as well as strong equity and capital ratios.
- Some challenges are a profit decline post-merger with Credit Suisse, high share price vs the moving average, and lackluster growth vs other global banking peers.
- The risk of rising corporate debt and interest expense is addressed.
Research Note Summary
As we approach the end of the first full trading week of November, I wanted to dive back into one of my favorite sectors to cover on Seeking Alpha, and that is financials.
In today's note, I'll be covering UBS Group AG ( UBS ), a Swiss-headquartered global bank that happens to also trade its shares on the NYSE as well, and just had its Q3 earnings release a few days ago.
Achieving media headlines this spring for its buyout of rival Credit Suisse , it presents an investing opportunity for an investor that wants some exposure to non-US based banks, but without the need to trade it via the European exchanges only.
After an analysis, I determined this stock should get a hold rating.
Some of its positives include revenue growth, positive cash flow and equity, outperforming the S&P500 index, and nice 3-year dividend growth along with net new client inflows.
Offsetting negative factors include an overbought share price, the costs of integrating post-merger with Credit Suisse, and a below-average dividend yield.
A risk discussed was elevated interest expenses and their business impact, offset by a strong capital ratio.
Methodology Used
My WholeScore Rating methodology looks at this stock holistically across multiple categories including key risks, and assigns a rating score. I exclusively cover stocks and foreign ADRs that are dividend-paying and trade on major US exchanges only (NYSE, Nasdaq).
Some of the data comes from the most recent FY23 Q3 results from Nov 7th, while the forward-looking sentiment relates to the upcoming FY23 Q4 earnings results expected on Feb. 6th.
Growth vs Industry Peers
This stock is in the segment of financials .
To put together a peer group to compare YoY revenue growth, I selected 5 very large "global" financial groups with sizeable US and European businesses, and all of which are traded on the NYSE either directly or as an ADR.
From this peer group, which averaged 25.3% in YoY growth, unfortunately UBS came in last with 4.7% YoY growth, missing my target and losing a rating point here.
This entire sector took a hit this spring during the regional bank failures of Silicon Valley Bank and Signature Bank, and the sudden buyout of Credit Suisse.
As someone who was home-based trading in this sector during that time, I know all too well the turbulence of that period, and the after-effects on this industry.
UBS, who I did trade at one point and was able to make a little profit from those price swings and volatility, was added to my portfolio watchlist mostly because it is one of the Financial Stability Board's list of global systemically important banks (2022).
One key metric important to this sector is net money flows into the bank, since this type of business makes a lot of money by looking after the capital of others.
The good news for UBS is that, according to their own Q3 earnings report, they did achieve positive new money particularly in their global wealth management practice:
UBS - net new money (company q3 results)
Here is another look at their net new money, in chart form:
So, I remain positive on UBS and will keep it on my watchlist at least for now, but would hope their Q4 results show even more top-line growth in relation to this peer group, which has some major whales like JPMorgan and Lloyd's.
Financial Statements
From the income statement , we can see that the YoY revenue growth of 39% easily beats my target, however the company missed on net income, with a decline of over 145%. The company explained it in their Q3 commentary as "driven by integration-related expenses," so it is an impact of the Credit Suisse acquisition and appears to be of a temporary nature.
I was impressed by the extreme YoY improvement in free cashflow per share, from their cash flow statement , as well as a 56% improvement to positive equity, from their balance sheet , both of which beat my targets.
So in a nutshell, the data story these statements tell me as an analyst or investor is that the firm is strong on cash flow and equity, as well as top-line revenue, but will need some time to improve profitability post-merger.
I look forward, therefore, to seeing the net income potentially "pop" in the Q4 results in a few months.
Dividends
It should be said that this stock, like several other foreign-based banks trading on the NYSE, does not have a quarterly dividend but an annual one. In fact, the last ex-date was April so it will be a while until the next payout.
However, if it is a stock I want to keep long-term for many years in a portfolio of bank stocks, what is relevant to me is the dividend yield and the dividend growth.
When comparing the annual dividend from April 2023 with April 2020, it shows a nice 56% growth. According to Seeking Alpha data , both the trailing twelve month and forward dividend growth are well above the sector average.
However, when it comes to yield, the forward yield of 1.11% is paltry compared to a sector that is nearly 4%. When comparing to some peers, you can see for example that an investor can get a yield of 2.91% from shares of JPMorgan Chase & Co. ( JPM ), and nearly 5% at Canada's The Toronto-Dominion Bank ( TD ).
So, I would not add this one to my dividend quick picks of the week due to the lack of quarterly dividend, and a below average yield, however thinking like a longer-term investor it has potential in a dividend-driven portfolio.
Share Price Vs. Moving Average
In this section, I look at the share price vs the 200-day simple moving average, to decide if I think it is too expensive right now.
As of the writing of this article, before market open on Friday Nov. 10th, the share price was hovering around $24.51, with the 200-day SMA being $21.93.
My portfolio looks for price dips of 5% or more below that 200-day average, to try and grab a lower price on a company that otherwise has strong financial fundamentals.
However, based on my table below, a share price of nearly 12% above the moving average would be too high in my opinion, though it does not mean it will not keep going up further.
What is interesting from the YCharts is that although UBS took a sudden dip during the spring banking calamity it remained well above its moving average as the chart shows, a sign that the market remains very bullish on this stock despite the headwinds to the industry overall. It also doesn't hurt that they were in a position to buy out one of the leading financial groups in the world, Credit Suisse.
Performance vs. S&P500 Index
The momentum of this stock is strong, with a 1 year price return of 49% and over 208% above the S&P500 index for that same period, earning another rating point from me.
This also seems to correlate with the price chart I mentioned earlier, as well as nice top-line revenue growth and this firm taking an even bigger market leading position now that its chief Swiss rival Credit Suisse is no more.
Its NYC-based banking peer JPM has seen a much smaller 1 year price return of just 11.21%, for example, underperforming the S&P, whereas Dutch peer ING Groep N.V. ( ING ) was able to outperform the index with a 1 year price return of 19.93%.
Again, more reason why as an investor I would consider adding some of these Europe-based banks to a global financial portfolio, to diversify exposure.
Valuation and ROE
The valuation picture of this firm tells an interesting story.
When it comes to the forward P/E ratio, we can see that it is just slightly overvalued when compared to the sector average of around 9.4x earnings.
The P/B ratio is showing undervalued at 0.93x book value, slightly below the sector average.
In terms of other metrics, the trailing return on common equity of 43.2% is a stunning 277% above the industry average.
Unlike some sectors like tech which have seen the market paying much higher premiums over book value, keep in mind that this sector has usually been closer to 1x book value. For instance, the trailing P/B for banking peer Lloyds Banking Group plc ( LYG ) is just 0.93, and that of ING is just 0.83. Now, that is a huge difference from the forward P/B of Facebook parent Meta Platforms, Inc. ( META ) of 5.37x earnings.
So, I think the price to book for UBS is a reasonable one at 0.93, as both equity and share prices have risen on a YoY basis as I've shown earlier.
The slight overvaluation on P/E may be driven by the spike in share price combined with the drop in earnings. Since the drop in earnings was affected by the Credit Suisse integration, in part, I expect the earnings side of that ratio to go up in the near future.
Key Risks
A merger or buyout usually has its risks, but it seems both the company and the market have absorbed the merger well and considering the alternative scenario of a complete bankruptcy by Credit Suisse I think this is the best scenario really.
A firm of this scale and capital level will be able to take the temporary hit to net income driven by merger costs, but the other risk I want to mention is corporate debt and interest expense, considering that the Fed after its November meeting decided to keep the policy rate where it is.
If you look at the table below, the benefit of high rates is seen with an over 200% YoY growth in total interest income. However, it also resulted in an over 400% YoY rise in interest paid on deposits at this bank.
The result was a YoY decline in "net" interest income.
Further, we can see that what appears to be long-term corporate debt has risen over 100% on a YoY basis.
Is this much cause for concern though?
Considering that UBS has $1.6T in assets on its balance sheet, I am on the fence about whether the amount of debt they carry is of significant risk, considering they are well capitalized and have a 14.4% CET1 capital ratio, well above regulatory minimums.
So, I am giving them a high probability of interest rate risk but low to modest business impact, and a total risk score that is tolerable.
In the comments section, I welcome a discussion on whether you think a firm like this will face growing credit risks in the next few quarters or not?
WholeScore Rating
Today I gave this stock a WholeScore of 6, earning a "hold" rating.
UBS - WholeScore (author analysis)
To compare my rating with that of the consensus, today I agree with the sentiment from SA analysts and the quant system which I think portrays this stock accurately right now, whereas Wall Street appears a bit too bullish.
UBS - rating consensus (Seeking Alpha)
My Forward-Looking Sentiment
This is one of those classic legacy global banks I would want in my portfolio to have some exposure to non-US large banks of systemic importance.
I don't think UBS is going anywhere anytime soon and so I personally would hold it, but it also is not much of a great dividend opportunity.
Looking forward, from the data presented I expect it to continue benefiting from net money inflows and income from its interest-earning assets, offset by the high costs of interest on deposits and new corporate debt issued.
For further details see:
Hold Rating For UBS As Profit Decline Overshadows Revenue Growth