UBS Is A Good Play For DGI

| About: UBS Group (UBS)

Summary

UBS is the largest global wealth manager and has very good growth prospects in this business, especially in Asia.

Its financial performance has been quite good over the past few, even though its earnings are still somewhat sensitive to cyclical factors.

Supported by its strong capitalization, UBS offers an attractive dividend yield of 3.8% and has very good dividend growth prospects for the next few years.

UBS Group (NYSE:UBS) is largely exposed to wealth management and enjoys strong growth prospects in the next few years, particularly in Asia where is the industry leader. Its capitalization is very strong, enabling it to offer an attractive shareholder remuneration. It currently offers a dividend yield of 3.8%, which is expected to increase in coming years through a growing dividend.

Company Overview

UBS a global firm providing financial services to private, corporate and institutional clients. UBS is one of the world's largest banks, being a global systemically important bank (G-SIB) with a buffer of 1%. UBS has offices in more than 50 countries and has about 60,000 employees. It has a market capitalization of about $61 billion and trades in the U.S. on the New York Stock Exchange. Its closest competitors are other global banks, including Credit Suisse (NYSE:CS), Deutsche Bank (NYSE:DB), HSBC (NYSE:HSBC), Goldman Sachs (NYSE:GS) or Citigroup (NYSE:C).

UBS has a balanced business mix, centered on the bank's global wealth management business and universal bank based in Switzerland. It also has significant operations in investment banking and asset management. UBS is the largest private bank globally, having more than $2 trillion of assets under management (AuM). It has a global footprint and benefits from significant scale within its industry.

Its geographical diversification is also good, even though Switzerland continues to be the most important market measured by profit (38% of the total), followed by Americas (30%), Europe (ex-Switzerland), Middle East and Africa (18%) and Asia-Pacific (13%).

Business Overhaul And Growth Prospects

Over the past few years, its strategy has been focused on expanding its wealth management operations, especially in Asia. The bank has successfully transformed its business model, being now much more exposed to asset and wealth management operations rather than investment banking. This means that UBS is now less reliant on capital markets activities, therefore having more stable revenues and earnings than a few years ago.

It has divested considerably from Investment Banking operations following the global financial crisis, given that it was one of the banks which was more aggressive in cutting capital-intensive fixed income, currencies and commodities [FICC] operations. UBS has now the lowest exposure to FICC and debt capital markets among the global investment banks, a strategic overhaul of its IB operations which has been successful.

UBS has had a return on equity [ROE] higher than most of its peers during the past few years, due to its focus on capital-light activities. Showing that bank's path was right, most of its competitors are also scaling back from debt capital markets and focusing more on less capital-intensive businesses.

Showing its push towards wealth management, UBS' wealth management business has shown good growth figures in the recent past, increasing significantly its weight on revenues and profits within the group. Indeed, in 2016, wealth management businesses generated almost half of UBS' profits, being the largest segment within the group. On the other hand, investment banking (IB) is now much smaller, representing only about 20% of the bank's profit.

Despite its already large weight within the group, UBS still has good growth prospects in wealth management. The bank has been pushing its operations into regions where it may have a better growth outlook in the long-term, namely in Asia.

Its AuMs in this region have increased significantly since its new business strategy was implemented in 2012 and UBS is now the largest private bank in Asia. The growth prospects in the region are quite good, due to the long-term trend of rising wealth in Asia which is not expected to slow down in the next few years.

The wealth management industry is still highly fragmented and growth is available for a large number of players, but UBS also has ambitious plans to increase its market share organically in the next few years. For instance, it plans to double its staff in China by 2020, which should be a supportive growth factor.

Additionally, UBS benefits from scale efficiencies and is currently highly profitable in Asia. This gives it to some extent a competitive advantage over its peers, given that UBS has already an established position and it may be hard for competitors to gain significant market-share due to UBS' scale and superior cost profile that may be difficult to replicate.

Financial Overview And Dividends

Regarding its financial performance, UBS has delivered improved results since its business reshaping in 2012, despite the challenging operating environment and significant litigation costs during this period. The bank has returned to report profits faster than its closest European competitors and has improved a lot its profitability, posting a return on equity of close to 12% in 2015, the highest within its peers.

However, its operating momentum has slowed down a bit in the past year, due to cyclical factors within its wealth management business. Due to events like the Brexit and the U.S. Presidential elections, clients were more risk-averse and activity decreased, impacting negatively UBS' results. Nevertheless, UBS was able to increase its net new money in wealth management businesses by CHF 42.2 billion ($43.3 billion), a remarkable achievement driven especially by Asia, which was the only region reporting net inflows during the whole year.

Reflecting its lower operating momentum in 2016, its net profit decreased by 48% to CHF 3.2 billion ($3.3 billion) and its ROE was 5.9%, a much lower level than in the previous year. Its earnings per share decreased to CHF 0.84 ($0.86). This drop in earnings was justified by lower revenues due to the weaker operating environment, but mainly due to higher restructuring costs, currency impact and higher tax expenses. On costs, UBS achieved higher net savings than expected, improving its efficiency.

During the first quarter of 2017, UBS' operating environment improved a lot showing that even though its business is now much more exposed to wealth and asset management, it is still cyclical and can have volatile earnings on a quarterly basis. Its net profit in the quarter increased by 79% to CHF 1.3 billion ($1.33 billion), with all business units reporting growth. Wealth management and investment banking had a particularly positive quarter, posting 19% and 51% pre-tax profit growth, respectively. This strong increase in profits is justified by the positive momentum in new money and margins within global wealth management, something that should be sustainable in the next few quarters.

Regarding its capitalization, like its peers UBS has increased significantly its capital ratios over the past few years due to higher requirements following the global financial crisis. At the end of the first quarter of 2017, UBS has a fully loaded equity tier 1 (FL CET1) ratio of 14.1%, which is comfortably above its medium-term target of above 13%. This shows that UBS has an excess capital position and is one of the best capitalized global banks in Europe.

However, to properly analyze its capital position, it is also important to consider the leverage ratio because the Swiss regulator also has focused on this ratio to determine the bank's capitalization. Current requirements set by the Swiss regulator were set at CET1 leverage ratio of 3.5% and total leverage ratio of at least 5%, while the difference between the two ratios should be complied with Additional Tier 1 [AT1] instruments.

On a fully-loaded basis, UBS has a CET1 leverage ratio of 3.55% and a total leverage ratio of 4.6%. This means that UBS complies with the CET1 requirement, but needs some improvement in its total leverage ratio. The bank intends to issue new AT1 securities when its current Tier 2 securities reach maturity or are called, thus the 5% leverage ratio should be easily be met. Therefore, UBS seems to be properly capitalized and is in a good position to distribute an attractive shareholder remuneration.

Regarding its shareholder remuneration, UBS has progressed positively over the past few years, resuming capital distributions in 2012 after several years of omitted payments. Following its organic reorganization in 2013, UBS resumed dividend payments related to 2014 financial year, paying ordinary and special dividends. In 2016, UBS paid only an ordinary dividend of CHF 0.60 ($0.62) per share, unchanged from the previous year.

At its current share price, UBS has a dividend yield of about 3.8%. Like many European companies, its dividend payment frequency is annual reducing its income appeal somewhat to U.S. investors, who generally prefer more frequent distributions. The dividend payout ratio was 71% in 2016, reflecting its drop in earnings. Its target is for a for a total dividend payout ratio of at least 50% of net profit, which means that most dividend growth should come from higher earnings rather than a more aggressive payout policy.

Going forward, UBS' commitment is to increase its ordinary dividend progressively and may pay special dividends again if its capitalization remains comfortably above its own targets. Indeed, according to analysts' estimates, UBS has very good dividend growth prospects driven mainly by higher earnings given that its dividend is expected to increase by about 14% annually in the next three years, while at the same time its dividend payout ratio should decrease to 55% during this period.

Conclusion

Following its business restructuring performed a few years ago, UBS is now a large wealth management company with very good growth prospects, especially due to its exposure to Asia. This should support its earnings growth in the next few years, even though its recent financial performance shows that its earnings can still be affected by cyclical factors.

UBS has a very strong capitalization and is in a very comfortable position to offer an attractive and growing dividend in the next few years. Its current yield is not among the highest in the European banking sector, but UBS has stronger growth prospects than most of its peers being therefore quite attractive for dividend growth investors.

Disclosure: I am/we are long C.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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