Elevator Pitch
I maintain my Bullish rating on Korea-listed financial services company KB Financial Group Inc. (NYSE:NYSE:KB) [105560:KS].
This is an update of my prior article on KB Financial Group published on May 26, 2020. KB Financial's share price has increased by +16% from KRW31,100 as of May 22, 2020 to KRW35,950 as of July 30, 2020 since my prior update. KB Financial trades at 0.37 times P/B, which represents a significant discount to its historical five-year and 10-year average P/B multiples of 0.54 times and 0.62 times, respectively. The stock is also valued by the market at 4.6 times consensus forward next twelve months' P/E, and it offers a consensus forward FY2020 dividend yield of 5.6%.
KB Financial's net profit attributable to equity holders grew by +34.6% QoQ to KRW981.8 billion in 2Q 2020, but market consensus still expects a -10% QoQ decline in its earnings for full-year FY2020. The company expects its net interest margin to bottom out in 2H 2020, and its asset quality remains healthy.
Separately, global private equity giant The Carlyle Group (CG) recently invested in KRW240 billion worth of exchangeable bonds issued by KB Financial Group. There is at least a 33% upside to KB Financial's share price, assuming the exchange price for Carlyle Group's exchangeable bonds is a fair reflection of the KB Financial's intrinsic value. As such, I retain my Bullish rating on KB Financial.
Readers have the option of trading in KB Financial shares as ADRs on the New York Stock Exchange with the ticker KB, or on the Korea Exchange with the ticker 105560:KS. For KB Financial shares listed as ADRs on the New York Stock Exchange, average daily trading value for the past three months is decent at $6.5 million, but lower than that for the Korea-listed shares.
For KB Financial shares listed in Korea, there are limited risks associated with buying or selling the shares in terms of trade execution, given that the Korea Exchange is one of the major stock exchanges that is internationally recognized and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $75 million and market capitalization is above $11.5 billion, which is comparable to the majority of stocks traded on the US stock exchanges. Institutional investors who own KB Financial shares listed in Korea include The Vanguard Group, BlackRock, Norges Bank Investment Management, Lazard Asset Management, and Invesco Asset Management among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.
2Q 2020 Results Were Better Than Expected
KB Financial announced the company's 2Q 2020 financial results on July 21, 2020, and its financial performance in the most recent quarter was better than expected. KB Financial achieved a net profit attributable to equity holders of KRW981.8 billion in 2Q 2020, which represented a strong +34.6% QoQ growth and a marginal -0.1% YoY decline.
The company's good performance in 2Q 2020 was largely attributable to decent loan growth and a reversal of certain valuation losses and provisions incurred in 1Q 2020.
KB Financial had earlier guided for FY 2020 loan growth in the +5-6% range. It delivered a QoQ loan growth of +2.4% in 2Q 2020, which brought 1H 2020 YoY loan growth to +6.8%, which is ahead of the company's FY2020 loan growth guidance and target.
Also, in my earlier article on KB Financial published on May 26, 2020, I noted that part of the "losses resulting from the volatility in financial markets in 1Q2020" are likely to "be reversible in subsequent quarters." KB Financial recognized gains of KRW18 billion and KRW76 billion with respect to credit valuation adjustments and reversals of provisions, respectively in 2Q 2020.
KB Financial's net profit attributable to equity holders declined by -6.8% YoY from KRW1,836.8 billion in 1H 2019 to KRW1,711.3 billion in 1H 2020, and market consensus expects the company's net profit attributable to equity holders to decrease by -10% YoY to KRW2,984 billion for full-year FY2020.
On one hand, KB Financial's loan growth could slow in 2H 2020. At the company's 2Q 2020 earnings call on July 21, 2020, KB Financial disclosed that "we are going to focus on profitability and asset quality" and "a very conservative loan policy" in the second half of the year. The company added that "there will be limited growth factors for loan growth in the second half of this year."
On the other hand, KB Financial will witness an earnings boost from acquisitions this year. It acquired a 70% equity interest in PRASAC Microfinance Institution, Cambodia's largest micro-finance company in Cambodia the first half of the year; and its acquisition of Prudential Life Insurance Co. of Korea, Prudential Financial Inc.'s (NYSE:PRU) Korean subsidiary, is expected to be completed in the third quarter of 2020.
Furthermore, KB Financial should continue to see improved profitability with better cost control. Its cost-to-income ratio declined from 50.9% in 2019 to 48.5% in 1H 2020, which the company attributed to "group-wide cost cutting efforts." KB Financial's medium term target is to reduce its cost-to-income ratio further to the mid-40s.
KB Financial's net interest margin and asset quality are key areas to focus, and I elaborate on them in the subsequent sections of the article.
Net Interest Margin Decline Is In Line With Expectations
At the group level, KB Financial's net interest margin was 1.74% in 2Q 2020, which implied a -10 basis points QoQ decline and a -23 basis points YoY decrease. KB Financial's bank net interest margin decreased from 1.70% in 2Q 2019 and 1.56% in 1Q 2020 to 1.50% in 2Q 2020. This was no surprise, considering that Korea's benchmark interest rate has been reduced by -75 basis points since March 2020.
Sell-side analysts see KB Financial's group net interest margin declining from 1.94% in FY2019 to 1.74% and 1.73% in FY2020 and FY2021, respectively. KB Financial has guided at the company's recent 2Q 2020 earnings call on July 21, 2020 that it expects its bank net interest margin to be 1.50% for full-year FY2020, with the bank net interest margin bottoming out in the second half of the year.
Asset Quality Remains Healthy
KB Financial's asset quality has remained healthy, despite concerns of a rise in defaults due to the economic fallout brought about by COVID-19.
The company's Non-Performing Loans or NPL ratio was low at 0.48% as of end-2Q 2020, while its NPL coverage is reasonably high at 144.4% at the group level (or 134.5% at the bank level). KB Financial's group credit cost grew from 0.25% in 1Q 2020 to 0.29% in 2Q 2020, while its bank credit cost increased from 0.11% to 0.12% over the same period.
Notably, KB Financial has guided for credit cost to remain below 0.30% for 2020. The company added at the recent 2Q 2020 earnings call that it expects credit cost to stay below 0.40% even in the worst case scenario involving assumptions of rising US-China trade tensions and new waves of COVID-19 infections.
High Exchange Price For Recent Bonds Issuance Suggests That Company Is Undervalued
In June 2020, KB Financial raised KRW240 billion with the issuance of zero-coupon exchangeable bonds to global private equity giant The Carlyle Group. Under the terms of the exchangeable bonds, The Carlyle Group has the right to convert its exchangeable bonds to 5 million shares (about 1.2% of total shares outstanding) of KB Financial Group for an exchange price of KRW48,000 for the period between August 29, 2020 and June 16, 2025. There will not be any dilution for existing shareholders, as KB Financial is setting aside treasury shares for the exchange of shares as part of the deal.
KB Financial currently trades at a 25% discount to the exchange price for The Carlyle Group's exchangeable bonds. In other words, there is at least a 33% upside to KB Financial's share price, assuming the exchange price for Carlyle Group's exchangeable bonds is a fair reflection of the KB Financial's intrinsic value.
At the company's 2Q 2020 earnings call on July 21, 2020, KB Financial emphasized that KB Financial's "undervalued corporate value and growth potential were recognized" as part of the recent exchangeable bonds deal with Carlyle Group as evidenced by the relatively high exchange price for the company's shares.
Valuation And Dividends
KB Financial trades at 0.37 times P/B based on its share price of KRW35,950 as of July 30, 2020. As a comparison, the bank's historical five-year and 10-year average P/B multiples were 0.54 times and 0.62 times, respectively.
The stock is valued by the market at 4.6 times consensus forward next twelve months' P/E, versus its historical five-year and 10-year mean forward P/E multiples of 7.2 times and 7.6 times, respectively.
KB Financial offers consensus forward FY2020 and FY2021 dividend yields of 5.6% and 6.1%, respectively.
Risk Factors
The key risk factors for KB Financial include weaker-than-expected net interest margin, a deterioration in the company's asset quality, and lower-than-expected dividends in the future.
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