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1) Japanese Banks have lagged the global rally
2) Why we’re buying MUFG
Incredibly Attractive Valuation
Low P/B of 0.36x despite owning 21% of Morgan Stanley (which trades at 1.35x P/B). Based on historical ROE and P/B trends for MUFG, we’re anticipating a valuation re-rating by mid 2021.
High Dividend Yield of 5.5%
At its current share price, MUFG’s dividend yield is 5.5%. MUFG did not have to cut its dividend this year and the current dividend per share is expected to be sustained in 2021.
Restart of Share Buybacks
3) Analyst Ratings for MUFG
The InvestQuest View
We see MUFG as a compelling investment given its 21% stake in Morgan Stanley, its attractive dividend yield, as well as the potential for sizeable share buybacks. MUFG has lagged the November stock market rally (where we saw a lot of global banking peers do well), so we see an opportunity for the stock to play catch up. In addition, there’s room for significant valuation rerating as operations improve post-Covid. For the purpose of our own investment, we estimate a fair value of JPY 575 for MUFG in 2021, representing a 25% implied upside from current levels.
Happy New Year, everyone!
Disclaimer: As always, our articles are meant to document our own decision-making process for our investments. Please do not take this as financial advice in any form and do your own due diligence when making financial/investment decisions. We bought into MUFG on 30th December 2020 & 4th January 2021, and have since taken profit on the position on 13 February 2021 for a 25% gain.
1) Japanese Banks have lagged the global rally
Japanese Bank stocks have lagged the broader market recovery this year, and more recently during the November rally.
Here’s the total returns (including dividends) of global banks since the start of 2020.
Below, we show each bank’s ROE vs Price-to-Book. ROE is a measure of profitability. Generally, the higher the ROE, the higher a Price-to-Book valuation the bank should be able to trade at on the stock exchange. Japanese banks have low ROE, but so do European Banks which are trading at higher Price-to-Book multiples.
When investors talk about Japanese Bank stocks, it’s common to hear comments such as:
- They won’t do well, especially with negative interest rates in Japan
- Economic growth in Japan is limited and weighed down by the country’s aging population
- Stock valuations are cheap and it has been this way for a long time
These concerns are valid, but to various degrees. European Banks face the same issues as Point 1 and 2, and have similar ROEs… yet European Banks are trading at valuation multiples that are 50% higher. As for Point 3, Japanese Banks are almost the cheapest they’ve been since 2011 (see below).
As a whole, Japanese Megabanks are currently trading at undemanding Price-to-Books (0.36x to 0.39x) as well as at high dividend yields (5.5% to 6.0%!).
We’re most keen on Mitsubishi UFJ (MUFG). Very importantly, it owns 21% of Morgan Stanley, a stock which rallied 41% in Nov-Dec 2020. In comparison, MUFG had only rallied 11% in the same time period.
- This 21% stake in Morgan Stanley is currently valued at US$26bn, or 43% of MUFG’s current market cap.
- Yet MUFG trades at 0.36x Price-to-Book, a steep discount to Morgan Stanley’s 1.35x.
- MUFG did not have to cut its dividend this year and the current dividend per share is expected to be sustained in 2021. At its current share price, the dividend yield is 5.5%.
- Furthermore, there is a possibility for the resumption of significant share buybacks as soon as end-2021.
Read on for elaboration!
2) Why We’re Buying MUFG
- Very attractive valuation & potential for rerating
- High dividends to be sustained
- Share buybacks as icing on the cake!
Incredibly Attractive Valuation
Low P/B despite owning 21% of Morgan Stanley
MUFG owns 21% of Morgan Stanley! But there’s a big Price-to-Book differential between the two stocks.
- MUFG currently trades at 0.36x P/B
- Morgan Stanley trades at a 1.35x P/B.
We have plotted the P/B ratios of MUFG and Morgan Stanley in the chart below. Historically we see the valuations of both banks moving strongly in tandem but this relationship has weakened significantly this year. We think that this is a good set up for a potential catch up play for MUFG.
This 21% stake is worth 43% of MUFG’s current market cap, the highest ever
MUFG’s 21% stake in Morgan Stanley is worth US$26bn right now, taking Morgan Stanley’s share price. This makes up 43% of MUFG’s current market cap.
Below shows how big the Morgan Stanley stake has been relative to MUFG’s entire market cap since FY16.
Based on our rough calculations, this implies an even lower 0.32x P/B for MUFG (ex-MS)
What does the above imply for MUFG (ex-Morgan Stanley)? We had to make some assumptions, but based on back-of-the-envelope calculations (see Appendix 1), we arrive at an implied P/B of 0.32x for MUFG (ex-MS).
In our view, MUFG’s operational weakness has been more than priced in
As a bank, MUFG’s operational performance has and will be affected by Covid-19. But to what extent has this already been priced in by the market?
Management has been fairly conservative in providing earnings guidance. For instance, even after raising the forecasts post-results, 1H net profits (half-year ending 30-Sep 2020) remain at 67% of the full-year guidance.
In our view, it’s likely that MUFG’s operational weakness has been more than sufficiently priced in by the market. We expect FY21 to be a period of transition to normalization and FY22 to be a year of normalization for MUFG.
Here are the analyst projections for MUFG’s operating income in FY21 and FY22. The chart below shows the operating income of MUFG, and the firm’s stock price since 2011. We note a positive correlation between the two, and am comforted that the firms’ operating income is expected to pick up in FY21 and FY 22.
For our own investment, we’re anticipating a valuation re-rating by mid 2021
Don’t be scared off by the chart below! Each point represents a snapshot of MUFG at each quarter in its history since 2011. The snapshot is of the Bank’s ROE at the time (x-axis), as well as the MUFG’s Price-to-Book.
Currently, MUFG is trading at a 0.36x P/B and has a low ROE of 1.9% (green dot in chart below).
With the expected improvement in earnings going forward, MUFG should trade at a higher P/B multiples (see red dots). This is what we are projecting based on MUFG’s past earnings and share price performance.
We expect MUFG to trade at 0.45x and 0.47x book value in Mar-2021 and Mar-2022 respectively, representing a 25% implied upside. This is based on analyst consensus ROEs of 3.9% and 4.4% for Mar-2021 and Mar-2022 respectively.
This translates to a MUFG target price of JPY 577 and JPY 602 for Mar-2021 and Mar-2022. This would imply that there is fair bit of upside from MUFG’s current stock price of JPY 456.
High Dividends of 5.5%
At its current share price, MUFG’s dividend yield is 5.5%. This is attractive relative to the bank’s average dividend yield of 3.3% in the past decade (see chart below), and may provide some downside support to the stock price.
MUFG did not have to cut its dividend this year and the current dividend per share is expected to be sustained in 2021.
MUFG has a strong track record of dividend growth. Since 2006, the bank has grown its dividend per share by 7.6% compounded annual growth rate (CAGR).
Restart of Share Buybanks
Good to Know: Sales of Non-Core Equity Stake
In short, because of its investment banking activities, Japanese Banks have substantial non-core equity holdings in various listed companies.
MUFG has been trimming these non-core equity holdings over the years and will be continuing this process. This extra cash can then go to funding MUFG’s share buybacks.
The box in red below shows the amount of cash raised when they reduce these equity holdings, which is typically between JPY 200-300 billion annually. This cash can then be used for the firm’s operations or for share buybacks.
How large will these Share Buybacks be?
In previous years, share buybacks ranged from ¥50bn to ¥200bn. See the table below.
Against MUFG’s market cap of ¥6.2tn today, ¥50bn to ¥200bn translates to ~1% to 3% respectively.
Adding that to today’s dividend yield of 5.5%, that’s potentially 6.5% to 8.5% shareholder returns in a year!
When will these Share Buybacks happen?
The expectation is for these share buybacks to happen closer to end-2021.
Notwithstanding the above, current market conditions are actually opportune for MUFG to conduct share buybacks since the Nikkei has reached a 30-year high (despite the banks underperforming) and many of the non-core equity stakes should have done well. We’ll consider it a positive catalyst should the share buybacks be conducted earlier than expected.
Following the cue from the Fed?
In addition, Mizuho Research has pointed out that the Fed has permitted the restart of share buybacks for US Banks under certain conditions. While Japanese Banks haven’t been under any similar share buyback restriction, Mizuho analysts believe that the Japanese Banks had taken the initiative to curb share buyback activities following cues from global peers. With the share buyback restriction now lifted in the US, this could potentially lead to a change in posture from the Japanese Banks.
Analyst Ratings for MUFG
In the below table, we list the analyst target prices that have been reviewed from November 2020 onwards. The median analyst target price is JPY 570, implying a potential upside of 25% from MUFG’s current price of JPY 456.
The InvestQuest View
We see MUFG as a compelling investment given its 21% stake in Morgan Stanley, its attractive dividend yield, as well as the potential for sizeable share buybacks. MUFG has lagged the November stock market rally (where we saw a lot of global banking peers do well), so we see an opportunity for the stock to play catch up. In addition, there’s room for significant valuation rerating as operations improve post-Covid. For the purpose of our own investment, we estimate a fair value of JPY 575 for MUFG in 2021, representing a 25% implied upside from current levels.
Happy New Year, everyone!
Disclaimer: As always, our articles are meant to document our own decision-making process for our investments. Please do not take this as financial advice in any form and do your own due diligence when making financial/investment decisions. We bought into MUFG on 30th December 2020 & 4th January 2021, and have since taken profit on the position on 13 February 2021 for a 25% gain.
Appendix
Calculation of MUFG (ex-MS) Price-to-Book
To calculate the above, we compared
- MUFG’s Market Cap minus MS Stake (US$61bn – US$26bn = US$35bn)
- VS MUFG’s Net Asset Value minus MS Stake (US$129bn – US$19bn = US$110bn)
… and we arrive at an implied P/B of 0.32x for MUFG (ex-MS).
Note that the US$19bn figure is a rough estimate (we used 21% of MS’s total NAV), as we are not sure what’s the book value of the MS stake on MUFG’s balance sheet.
Hello! This is a very detailed analysis. Would you recommend buying the 8306 stock or the ADR? Seems like there is much more liquidity for 8306. Also, would there be a withholding tax on dividend from for Japan stocks?
Assuming no difference in brokerage charges, personally I prefer the Japan listing but frankly speaking, there won’t be much difference from a retail investor perspective currently.
As you mentioned, trading liquidity is higher for the Japan listing at around US$300m daily trading volume vs US$6m for the US listing. But this is pretty inconsequential for retail investors.
The difference in traded currency is also not that important a factor. Because if USD appreciates relative to JPY, you will see the US-listing perform worse than the Japan-listing in share price returns, to adjust for that.
So perhaps the biggest factor to consider is whether the US-listing is trading at a premium (after adjusting for the difference in FX) from the Japan-listing, which opens up a convergence trade opportunity. In the past five years, the US-listing’s stock price has diverged from the Japan-listing by a range between -8.4% cheaper to +7.3% more expensive, with an average close to 0%. At the moment, both the US and Japan listings are not diverging in valuation, so the opportunity does not exist currently and you would be indifference between buying the Japan or US listing.
For the Japan stock dividend withholding tax for SG investors, it should be 15.315% (which includes the 2.1% surtax on the 15% standard withholding tax)