DBS Group (OTCPK:DBSDY) management continues to do well relative to what it can control – spreads are okay, pre-provision profits have been growing, credit quality remains strong, and there’s a cogent plan in place to grow across multiple markets. The “but” is that there’s next-to-nothing management can do about the Singaporean government’s housing cool down policies, let alone the U.S. rate cycle and the trade tensions between the U.S. and China – the latter two issues seemingly weighing more heavily recently.
DBS shares haven’t done that well since I last wrote about the company, though they’ve done better than other Singaporean banks and most other banks in its operating theater. Although a credit loosening cycle in the U.S. and increased trade tensions could create some near-term challenges, I like the long-term outlook for mid-teens ROEs, higher dividends, and mid-to-high single-digit earnings growth. I still believe fair value lies above $90, so I think this sell-off is a buying opportunity for investors who can live with the risk of elevated near-term volatility.
Good First-Quarter Results
On balance, I thought DBS Group had a good first quarter, although non-interest income drove most of the beat vis a vis analyst expectations and that is seen as a somewhat lower-quality beat. Still, management reiterated confidence in a 13% ROE, mid-single-digit loan growth (despite soft prospects in Singapore housing), and more leverage to past U.S. Fed rate hikes.
Revenue rose about 6% year-over-year, with nearly 9% growth in net interest income. Net interest income was basically in line this quarter, with NIM up 5bp year-over-year on lagging benefits from U.S. rate hikes and over 6% growth in earning assets. Non-interest income surprised to the good, with roughly 1% year-over-year growth and 36% sequential growth. Card fees and transaction fees continue to grow strongly (up over 20% year over year).
Expenses outpaced revenue on a year-over-year basis (up 7%), but this was as expected. Pre-provision profit rose about 5% year over year, beating expectations by about 5%, and attributable profit rose 9%, beating expectations by more than 11%.
Mixed Trends On The Balance Sheet
Overall loans rose more than 7% yoy, and up a little less than 1% sequentially (2.4% annualized), coming in slightly below expectations. Housing remains weak, with housing loans (about 21% of the total) up just 1% yoy and down 1% qoq in large part due to the government of Singapore’s efforts to cool the housing market. Building and construction loans were up 15% yoy and down slightly qoq, and general commerce loans were down 10% yoy and down 2% qoq. Manufacturing was a bright spot, with 22% yoy and 10.5% qoq growth. By currency, Singapore and U.S. dollar-denominated loans were flat qoq, while HK dollar and Chinese yuan loans were up 1.6% and 3.1%, respectively.
Average loan yield improved more than half a point year over year and about 8 bps sequentially. Thus far, DBS and its Singaporean peers United Overseas (OTCPK:UOVEY) and Oversea-Chinese Banking Corp. (OTCPK:OVCHY) have seen a slower process of rate lift from the U.S. Fed cycle than in the past. Some of that is due to a shifting mix, but management has guided for further uplift as those rates work through into loan repricings over the next couple of quarters.
Deposit growth of 5% yoy was likewise a little shy of expectations, and DBS Group is seeing higher rates working through its funding costs, with total cost of funds up 44 bps yoy this quarter and customer deposit costs up 37 bps – both still below the loan yield uplift. Sequential deposit growth was flat in both Singapore and Hong Kong dollars, up 1% in U.S. dollars, and down more than 11% in Chinese yuan, leading to a sharp spike in the loan/deposit ratio for CNY to 111% versus a stable overall loan/deposit ratio of 89%. As a reminder, while DBS Group has long experience in managing its currency exposures, an extended imbalance between funding and lending in a currency can create some risk.
Credit quality remains fine, with the NPL ratio down again (down 13 bps yoy and 1 bp qoq), despite management having previously commented that the credit cycle was likely peaking.
Risks And Opportunities
Near-term, probably the biggest risk to DBS Group is the U.S. rate cycle and the U.S.-China trade tensions. The U.S. Fed could begin cutting rates next year, which would create new headwinds for the bank’s spreads; though these risks are manageable, it will be an impediment to growth. With U.S.-China trade tensions, the risks are hard to quantify. There’s plenty of business around the world that has nothing to do with the U.S. and China, but China’s economic health is tied to its trade relationship with the U.S. and further pressure here could have ripple effects on loan demand.
I think DBS’s risk to further slowing in the Singaporean housing market is probably pretty limited from here. What’s more, I think SE Asia should be in good shape economically (Vietnam, Indonesia, and Singapore), and that will benefit DBS’s groups operations.
Longer term, the bank also still has some attractive growth options. The company is looking to beef up its presence in consumer banking in Hong Kong, complementing its past successes in the mass-affluent segment, but will do so primarily through its digital platform. The bank is also scaling up its operations in Indonesia (an important growth market) and tweaking its approach in India – although India remains a promising market, so far customer acquisition costs have been too high and customer quality has been too low. I’m also looking for DBS to get more involved in Vietnam, but this will be a long process.
The Outlook
Although I’m actually modeling a little less than this, I do think DBS Group could hit a 13% ROE in 2019. Over time, I think there’s room for further upside on growth in the China/HK business, as well as emerging growth from markets like Indonesia. While I’ve trimmed back my three-to-five year expectations on a more challenging rate cycle and peaking credit quality, I’m still looking for long-term core earnings growth in the neighborhood of 7% to 9%. Based upon discounted core earnings and returns-driven P/BV, I believe DBS Group shares should trade in the $90s.
The Bottom Line
DBS Group is by no means immune to global economic growth or credit quality concerns, but I think the risks as reflected in the share price are too high. This can be a frustrating stock to own, but I think the long-term return potential makes it a hassle worth tolerating, and I like DBS Group as a way to gain exposure to SE Asia and China through a fairly conservatively-run leading bank in the region.
