DBS (Development Bank of Singapore)

[weijian]

hi ghchua,

I wouldn't be very excited if most of a "10%pa gains for next 5 years" are all FV property gains - can see, cannot touch kind.

Maintaining ROE can come in different manners - (1) Better/growing business economics, (2) borrowing more, (3) returning capital. Some folks may not like all of them. For example, I generally avoid (2) but I cannot rule out that some businesses are ok to borrow (more). But regardless, generally I think ROE is a reflection of a good steward of capital. Of course, it will not be the case when done at extremes, ie. the capital allocator over borrow, or over pay dividends or underinvest in CAPEX. And the inversion is mostly true - in the absence of a general crisis, low ROE is a reflection of a bad steward of capital, and that is mostly accurate.

Now back to DBS. If my memory serves me right, past bank acquisitions of banks generally get into trouble when the BV multiple go northwards above ~1.3x. Lady luck may not be shining on the investor who buys a "retail" bank at 1.5x but it could be more of a problem with overpaying for a "quality asset". And now for the inversion - For anyone to pay 0.5x BV for a bank, they have to get ready for some "rude shock" in terms of quality that may or may not be obvious at the onset....

I for one, would be looking for a quality asset trading at 1-1.3x BV, and be cautiously optimistic that its quality will allow its BV to keep compounding faster or even the possibility of having the Market to re-rate its BV multiple upwards, compared to let's say, a cheaper lower quality asset that perpetually trades at 0.7x BV and then have a real risk to be re-rated to 0.5x BV.

[ghchua]

Hi weijian,

I wouldn't be very excited if most of a "10%pa gains for next 5 years" are all FV property gains - can see, cannot touch kind.

The above comment was given by me tongue-in-cheek. Because I couldn't understand the "excitement" by the market for a stock that just maintain their ROE numbers only.

Maintaining ROE can come in different manners - (1) Better/growing business economics, (2) borrowing more, (3) returning capital. Some folks may not like all of them.

For a bank itself, the bread and butter is their lending business. NIM and volume growth is the main driver of ROE for this business. Unfortunately, this part of the business had been squeezed by interest rate movements. Therefore, in order to drive further growth, acquisitions have to take place. There is only so much one can grow in Singapore. Better ROE business actually comes from their non-lending interest income businesses and those that are more asset light. But the main part is still the lending business. That is where most assets are allocated to for a bank business.

I for one, would be looking for a quality asset trading at 1-1.3x BV, and be cautiously optimistic that its quality will allow its BV to keep compounding faster or even the possibility of having the Market to re-rate its BV multiple upwards, compared to let's say, a cheaper lower quality asset that perpetually trades at 0.7x BV and then have a real risk to be re-rated to 0.5x BV.

Why wouldn't a 0.7x BV company be re-rated upwards instead? Why wouldn't a 1-1.3x BV company be re-rated downwards instead? In a crisis, all will be re-rated downwards. It is just market perception of future earnings potential of a company you have invested in. Generally, there is not much money to be made if you agree with market valuation and definitely much to lose if you overpaid for a company, even if it is a good one.

[weijian]

I for one, would be looking for a quality asset trading at 1-1.3x BV, and be cautiously optimistic that its quality will allow its BV to keep compounding faster or even the possibility of having the Market to re-rate its BV multiple upwards, compared to let's say, a cheaper lower quality asset that perpetually trades at 0.7x BV and then have a real risk to be re-rated to 0.5x BV.

Why wouldn't a 0.7x BV company be re-rated upwards instead? Why wouldn't a 1-1.3x BV company be re-rated downwards instead? In a crisis, all will be re-rated downwards. It is just market perception of future earnings potential of a company you have invested in. Generally, there is not much money to be made if you agree with market valuation and definitely much to lose if you overpaid for a company, even if it is a good one.

Hi ghchua,

Of course 0.7x BV can re-rate upwards and a 1.3x BV company can be re-rated downwards. I think we are nuancing over odds here.

When a company is perpetually at 0.7x BV, the reason/s for the discount has a higher chance to maintain/increase the discount) than a new reason reducing it.

When a company is perpetually at 1.3x BV, the reason/s for the premium valuation has a higher chance to maintain/increase the premium than a new reason reducing it.

[ghchua]

Hi weijian,

Frankly speaking, if a company needs to be valued using BV, it just means that it is not exhibiting high growth attributes. That is what I am trying to say here. The chances of BV re-rating at 1.3x BV is not high, as compared to one that has 0.7x BV.

High growth companies are mostly valued using PE multiples.

[weijian]

hi ghchua,

I thought we were actually talking about banks here? Anyways, the BV multiple is just 1 of the many techniques, just like PE multiples. We could say high growth companies are mostly valued based on PS multiples! which itself is also 1 technique.

[ghchua]

hi ghchua,

I thought we were actually talking about banks here? Anyways, the BV multiple is just 1 of the many techniques, just like PE multiples. We could say high growth companies are mostly valued based on PS multiples! which itself is also 1 technique.

Yes. We are on the same page. My point is that banks are not supposed to be high growth companies because their main bulk is lending business, which is asset heavy. That's why they are being valued at BV multiples and not PE multiples.

You can't be valuing a business using BV multiples and say they are high growth companies. Which is why I am saying that there is a limit on how much DBS can grow going forward. Which goes back to my point that at a BV multiple of 1.5x currently, there is limited scope for BV multiple expansion for DBS.

[weijian]

Yes. We are on the same page. My point is that banks are not supposed to be high growth companies because their main bulk is lending business, which is asset heavy. That's why they are being valued at BV multiples and not PE multiples.

You can't be valuing a business using BV multiples and say they are high growth companies. Which is why I am saying that there is a limit on how much DBS can grow going forward. Which goes back to my point that at a BV multiple of 1.5x currently, there is limited scope for BV multiple expansion for DBS.

hi ghchua,

Thanks for the clarification. Let me clarify on my part - I do not think banks (or DBS) is a "high growth company" (lets define it as 30% CAGR type of revenue/profit sort). But I think we cannot deny that banks have very good economics, a very good proxy play to the economy of a country, and most importantly, back stopped by a regulator who also act as a money printing machine at many times.

My main aim of using BV to do illustrate - as I had mentioned earlier - is to gauge Mr Market's judgement on its quality (for this case, financing firms) and then from there, work backwards to see whether Mr Market is right or wrong. So far, I have largely observed that, in the absence of a crisis, Mr Market is quite on cue most times (not all times).

For sure, DBS will be limited by how much Spore grows. And after previous mistakes (eg. buying Dao Heng Bank at 3.3x BV?), it looks to have grown wiser and only did for smaller/cheaper acquisitions in AP region, by buying over from Western banks who are refocusing back home. IMHO, these are incremental and correct usage of its excess capital. I am "excited" about DBS because it looks to ticking the boxes of a  good allocator of capital, not its "growth prospects". Been a good allocator of capital, unfortunately, is the exception and not norm on the local bourse.

[ghchua]

Hi weijian,

It is alright to bet on a good capital allocator, but do remember than DBS is a professional managed outfit. CEO will come and go. Unless there is a long embedded culture in the company of good capital allocation, a new CEO sometimes might turn things around and have his own new idea of doing things.

[weijian]

Hi weijian,

It is alright to bet on a good capital allocator, but do remember than DBS is a professional managed outfit. CEO will come and go. Unless there is a long embedded culture in the company of good capital allocation, a new CEO sometimes might turn things around and have his own new idea of doing things.

hi ghchua,

What would be the alternative? Betting that the visionary founder has similarly capable offspring?

Come and go CEO, in a meritorious manner? OR It's in Our family, like Kwek Junior making bets to make his mark at CDL, or those that have the whole clan working in the company and make property investments (that are non core to ops) to hold across generations?

Well, at the least the former has a mechanism to make changes! But of course, no system is best and everything needs to be adopted accordingly to needs and available resources at that point of time. We as OPMIs, are on the look out for exceptions to the norm.

[ghchua]

Come and go CEO, in a meritorious manner? OR It's in Our family, like Kwek Junior making bets to make his mark at CDL, or those that have the whole clan working in the company and make property investments (that are non core to ops) to hold across generations?

Hi weijian,

It all boils down to valuation. I have no preference on either. Would you like to buy a family owned business like Sing Investment & Finance at 0.5x PB or a professionally run outfit like DBS at 1.5x PB?

Unfortunately, I have no answers to your questions. But being a deep value investor at heart, I would always certainly go for a cheaper stock in most (not all) circumstances.

However, I understand that some investors might prefer higher ROE businesses, and therefore they would have to pay for them accordingly in a form of higher PB valuations.