Seeking Alpha • Aug 10
Woori Financial: 98% Net Income Growth YoY, Yet Trading At P/B Of 0.33
Woori Financial Group is one of the big four South Korean banking institutions holding 12% of the banking system's total loans and 14% of deposits.
Net income grew 98% YoY on revenue growth of 22.3% YoY. In their press release for first half results they breakout that first half revenue grew 61% over last year.
Assuming a conservative re-rating of P/B value to 0.5 from current levels of 0.33 implies a margin of safety of 64%.
There are risks related to a broader South Korean economic bubble which I discuss as well.
Woori Financial (WF) is the smallest of the big four Korean banks which historically has traded below its peers in terms of valuation for two reasons: (1) worse performance metrics and (2) government ownership of shares. All four of the banks have announced quarterly earnings already and given a review of first half performance, and it seems that Woori may be taking a turn for growth. Additionally, government ownership is down to just 3.6% of shares outstanding with a stated goal to divest fully by the end of this year.
The market currently values Woori at a P/B of 0.33 and a P/E of 4.78 based on just the first half of this year’s earnings. Given rising interest rates and ongoing cost reduction via synergies I think it’s likely they can do at least as much in earnings in the second half which would value WF at a P/E of 1.76 based on an FY22 estimate.
While these valuations are low we should consider that Woori has traded at a discount to book for years so historical averages may be more helpful in getting the picture here. The three year average P/B is 0.36 and the P/E is 4.78. Based on these metrics we can see that Woori trades only slightly below average P/B though if earnings continue at this rate it’s well below average P/E. I think it’s more likely that WF will trade at the peer average P/E which would imply a 172% margin of safety.
Calculations assume a price of WF at $27.00.
Overview of Woori Financial Group and South Korean Banks
Woori is not alone in being discounted here as Korean banks overall trade at a significant discount to book value. Take these data points for instance from a Business Korea article:
The average PER of South Korean bank group stocks for the 10 most recent years is 4.0 whereas those of their counterparts in Germany, Finland, Singapore and the United States are 16.4, 11.4, 11.2 and 10.3, respectively,” it explained, adding, “In addition, the former’s average PBR is 0.36 whereas the figure is as high as 1.61 in the United States and 0.42 in China.
According to their review South Korea bank stocks trade at the second to lowest valuation compared to international peers. The only country with more undervalued banks is Russia. South Korea companies overall have tended to trade with what’s called the Korea Discount due to many of the top Korean companies being family run. Banks in particular were seen to be not shareholder friendly – though this has changed in the recent years as each of the larger Korean banks have made steps to engage in new tactics with regard to shareholders including share buybacks.
We’ve seen at Woori that they’ve targeted an increased dividend payout to 30% and stated in the last earnings call that they are “planning to review a wide variety of shareholder return options once COVID-19 stabilizes.”
I suspect that with changes in capital allocation approaches by South Korean banks, specifically share buybacks which could be hugely accretive, that they should start to trade closer to book value in the next 3-5 years. Rising interest rates are driving further earnings in the near term for deposits at banks. Woori Financial will benefit from this broadly though I think it’s the best pick amongst the bunch. If we look at P/E valuation based on first half earnings alone we can see the disconnect that's started with WF.
Peer Comparison
Market Cap
P/B
1H22 Earnings
P/E of 1h22
Woori Financial
8,413
0.33
1761
4.78
Shinhan Financial Group
(SHG)
18,805
0.39
2720
6.91
KB Financial Group (KB)
18,566
0.35
2756.00
6.74
Hana Financial
10,569
0.31
1727.40
6.12
14,088
0.345
6.14
*Data pulled from company filings.
Here are some other metrics related to first half performance amongst the peers.
Peer Comparison
NIM
Cost to Income
Credit Cost Ratio
Non-performing loans
NPL Coverage Ratio
CET-1
WF
1.83%
40.10%
0.29%
0.30%
210%
11%
SHG
1.58%
39.00%
0.31%
0.38%
209%
12.82%
KB
1.96%
46.50%
0.23%
0.32%
222.40%
12.93%
Hana Financial
1.80%
45.30%
0.23%
0.37%
188.40%
13.18%
Average
1.79%
42.73%
0.27%
0.34%
208%
12%
*Data pulled from company filings.
Some things I observe from above is that WF has above average net income margins, cost-to-income, and non-performing loans. Credit-cost and CET-1 are a bit higher for them than the group. Overall there is nothing that seems to suggest justification for a wide differential in P/E between Woori and its peers.
But we should put the most recent earnings into more context as WF have been growing net income to record levels in the past year and a half. Net income grew 98% YoY on revenue growth of 22.3% YoY. In their press release for first half results they breakout that first half revenue grew 61% over last year, net income grew 46%.
Earnings are growing at this pace given Woori Financial's expansion beyond bank services and digitalization efforts. All of the large South Korean banks have been expanding in this way as they look to compete more internationally by offering a more complete suite of offerings. In the conference call they noted that “the contribution of the nonbank business, which was 10% when we first created the holding company, has grown to 17.2% as of 2021 and broadening the profit base of the group.” This organic growth is supported by their low cost deposit base and is driving record earnings. With the company trading at distressed multiples, the compounding potential of earnings for anyone buying in now is high.
Let’s look at an example. Last year’s earnings came in at 2.762b KRW. First half net income was 1.762b KRW. Assuming no additional growth in earnings that would imply earnings of 3.524b KRW which would imply 28% growth for the year. If we apply the three year peer average P/E of 4.78 implied market capitalization would be 12.064b KRW compared to the current market cap around 8.413b KRW – an implied 43% upside assuming no growth. It’s more likely that the end of year figure will be above the 3.524b KRW estimate as interest rates drive earnings higher and organic growth continues within the company. If share repurchases are considered over the next year that could further compound returns as long as valuations remain low. Of note is that peers KB and SHG have both discussed initiating share buybacks this year given low P/B valuation. I think this is a trend opening up across these banks and we should see them beginning to use the lever of buybacks to help drive value given consistent prices below book value.
Government Overhang on Woori Financial Will Unwind This Year
Woori Financial began its process of becoming privatized in December 2014 with the South Korean government retaining around 17% of share outstanding. After many rounds of selling over the years they maintain around a 3.6% interest which they intend to sell out by the end of this year. This large block of shares that have been regularly unloaded has likely caused downward pressure in the name as well as a general discount given government ownership. We can also see that the ratings agencies have been noting this development as well. A note from Fitch in November 2021 highlighted:
The state's previously strong influence on Woori's management hindered the consistent execution of strategies, partly due to frequent changes in key managers, who often had less banking experience than those at peers. The state’s influence also led to heightened risk appetite, evident in aggressive credit expansion and delayed exposure reduction to troubled sectors, such as construction, shipping and shipbuilding, until the mid-2010s.
Such influence has reduced noticeably since 2017 when the board started to be controlled by members representing a handful of minority shareholders. More effective checks and balances and risk control have facilitated improvements in Woori’s financial profile to closer to the major local peers, leading us to upgrade the Viability Rating to 'a-' from 'bbb+' in July 2021. However, it remains to be seen whether the stability of the board can be maintained without a major or dominant shareholder.
Over the coming years I think we will see Woori Financial become more focused on overall shareholder return and growing their business. Without the overhang of government connection and intervention, management should be able to continue to execute against their growth plans to become a pan-Asian financial leader.
South Korea Real Estate Bubble Risk
There is currently fear of a real estate and economic bubble in South Korea which is hanging over the banks as well. In the event that there is a 20-40% downturn in real estate values as some fear, Woori Financial’s historic connections with the government may be advantageous.
In a scenario where real estate values see that kind of plunge Woori Financial has a few buffers in place that would mitigate impact. To start the company has loan loss reserves of 2.213b KRW. Their real estate exposure is tied to the 45% of their book which is retail loans. Of those loans, 70% are backed by real estate with an average loan-to-value ratio of 42.35%. These values are pretty similar across WF’s peers.
