DBS Group Executing Well, But Caught Up In U.S. Rate And U.S.-China Concerns

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.

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DBS Group Executing Well, But Caught Up In U.S. Rate And U.S.-China Concerns

DBS Group Executing On A High-Quality Growth Plan

While investors in North America and Europe have been selling off bank stocks to a degree that seems to price in a coming recession, Singapore’s banks have held up a little better. I was a little concerned about China-related macro risk and efforts to slow/cool Singapore’s housing market in reference to DBS Group (OTCPK:DBSDY) back in August, but the shares have done okay next to most global indices as housing, construction, and manufacturing-related demand have all held up reasonably well.

I continue to believe that DBS Group shares look appealing barring a global recession and/or a serious deterioration in China. Loan demand is likely to slow noticeably next year, but DBS Group should still be poised to benefit from some rate moves while credit quality remains benign. Longer term, I expect meaningful leverage from the company’s investments in digitalization and market entry/development in India and Indonesia.

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DBS Group Executing On A High-Quality Growth Plan

Quality Concerns Front-And-Center At DBS Group

It's a lot easier to lose a reputation than to gain it, and DBS Group (OTCPK:DBSDY) has investors worrying about whether they're about to see a flashback to the bad old days of unexpectedly high bad loans at this leading Singapore bank. With a major recent bankruptcy from a debtor that wasn't even flagged as a problem, concerns about credit quality, balance sheet quality, and even management quality are back in investors' minds. And if that weren't enough, China isn't exactly the picture of health and DBS is running out of levers to pull to keep its peer-high net interest margin strong.

I suppose the fact that the ADRs are only down about 6% since my last update is actually sort of good news given how sentiment has turned (the average sell-side target price is 15% lower than back in March). I still believe this is a good bank, but the sort of provisioning and credit losses that the bank reports over the next couple of years will show whether that belief is well-founded. I've cut my expectations to what looks like a low bar (roughly 2% growth over the next five years, and about 6% growth over the long term), but anyone who remembers back to our own banking crisis will know how badly wrong those projections can go if credit quality really falls away.

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Quality Concerns Front-And-Center At DBS Group

Seeking Alpha: DBS Group Has Been Beaten Down On Worries About China And Commodities

It has been a rough stretch for Singapore's DBS Group (OTCPK:DBSDY) since I last wrote about this leading ASEAN bank, with the shares down more than 20% and underperforming United Overseas Bank (OTCPK:UOVEY) (down about 19%) and Oversea-Chinese Banking Corp. (or OCBC) (OTCPK:OVCHY) (down 11%). While DBS Group actually hasn't performed that poorly from an operational view, with 2015 earnings pretty much in line with the expectations for 2015 back at the time of that last article, investors have grown increasingly concerned about the rate environment, the slowdown in China, the company's commodity lending exposure, and the prospect of higher loan losses.

While high-quality banks in difficult economies have shown in the past that tough times can definitely exceed management expectations (Brazil's Itau Unibanco (NYSE:ITUB) comes to mind), it seems as though the market is expecting DBS to see its non-performing loans jump from less than 1% today to 5% or more over the next couple of years. Possible? Of course. Probable? I don't think so.

In what I think is a relatively bearish scenario (cumulative 2016-2018 earnings about 5% below the current sell-side expectations), DBS Group's ROE slips below 10% for a few years, but the bank would still grow earnings at a roughly 4% annualized rate over the next five years and closer to 6% over the long term (consistent with a low-double-digit ROE). That would support a fair value of over $52 on the ADRs today. If management is right about its loan growth and credit loss experience (in other words, better than the sell-side expectations and better than that bearish outlook), the fair value moves into the mid-to-high $50s relatively quickly.

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DBS Group Has Been Beaten Down On Worries About China And Commodities