Financial Adviser: 5 Reasons Why Metrobank Is the Most Undervalued Bank Stock Today and How to Profit from It
Bank stocks have been one of the worst-performing sectors in the stock market since the outbreak of the COVID-19 pandemic last year.
The Financial Sector index, which has been falling since the market top in 2018, was the worst performing sector since the start of 2020, losing 23 percent compared to the Philippine Stock Exchange Index’s loss of 13 percent.
One of the main reasons why banks have done poorly was due to the rising fear of loan defaults due to corporate losses caused by the mandated government lockdown last year.
The fall of interest rates to historic lows along with contraction in the economy has also raised concerns of slowdown in bank earnings growth.
But with the gradual reopening of the economy this year and the promise of a quicker vaccine rollout, things are beginning to look up in the banking sector.
Unlike in the past financial crises, banks today play an important role in the recovery process by extending credit and restructuring problematic debts of financially troubled companies.
Following the implementation of the Basel III framework, bank capital is also stronger now, which can support the sector to withstand any doomsday crisis.
The expected recovery in the economy this year, albeit slowly, and the stable rise in interest rates make bank stocks ripe for the picking.
Among the top three largest banks in the country, Metrobank (PSE: MBT) appears to be most promising to recover strongly, being the most undervalued fundamentally.
MBT is currently trading at 30 percent discount to its net book value, or 0.7 times Price-to-Book (P/B) ratio against BDO Unibank (PSE: BDO) and Bank of Philippine Islands (PSE: BPI), which are both priced above their book values by about 25 percent.
MBT has also lost the most value since the PSE Index topped in early 2018, losing as much as 45.8 percent from its high to its price today, compared to BDO’s loss of 37.4 percent and BPI’s 25.9 percent.
As in any value stock, it is always good to spend some time understanding the business of the company and evaluate its long-term potential.
The more you know about the fundamentals of the company, the better your chances in handling your investment risk and returns.
Here are the top five things every value investor needs to know about Metrobank stock:
1| Know the earnings prospects of the company
Basic macroeconomics will tell us that the banking sector plays a critical role in the growth of the economy.
A strong banking system makes an economy more resilient to negative shocks, while at the same time, a healthy economy increases banks’ profitability.
History has shown that Metrobank’s (PSE: MBT) total revenues are highly influenced by the growth of the economy with over 90 percent correlation.
Over the years, the growth in real Gross Domestic Product (GDP), which increased by an average of 6.0 percent per annum resulted to 10 percent annual growth in MBT’s total net revenues, which increased from P42.7 billion in 2009 to P106 billion in 2019.
The growth in MBT’s total revenues, which comprises 73 percent of net interest income and 27 percent non-interest operating income, translated to an average annual earnings growth of 17 percent from P6.0 billion in 2009 to P28 billion in 2019.
Last year, while the economy declined by 9.5 percent due to the outbreak of coronavirus pandemic, MBT still managed to increase its total net revenues by 14 percent to P121.9 billion in 2020.
The increase in total net revenues would have increased MBT’s earnings by roughly 26 percent, but because management proactively increased its provision for bad loans by 304 percent from P10 billion in 2019 to P40.8 billion in 2020, net earnings declined by 51 percent to P13.8 billion.
With strong buffer against rising risk of bad loans, MBT should be able to focus on recovering its earnings this year.
Considering that it is coming from a low base in 2020, a growth in GDP to 6 percent this year should enable MBT to increase its total net revenues by 15 percent, which could easily grow its net earnings significantly.
2| Know the financial strength of the company
Studies show that an increase in capital is often associated with an increase in loan growth, which means that better capitalized banks emerging from a financial crisis can expand lending activities more quickly.
It has been said that well-capitalized banks can serve as a source of strength for the economy in good times and bad.
Based on December 2020 balance sheet, MBT enjoys highest capital ratios in the industry. Its capital adequacy ratio (CAR), which measures stability and efficiency of the bank to protect depositors, is strongest in years at 20.2 percent, more than double the minimum regulatory threshold of 10 percent.
On the other hand, MBT’s capital equity tier-1 (CET-1), which measures a bank’s liquidity and ability to absorb losses and survive a challenging financial crisis, is also highest at 19.3 percent, almost double the minimum requirement of 11 percent.
High capital ratios reflect MBT’s strong financial position, which should merit premium to its share price valuation.
3| Know the management competency and track record
There are three key metrics that investors normally look for in a bank to assess its management’s ability to generate value for their shareholders: Return on equity (ROE), Return on Assets (ROA) and efficiency ratio.
MBT’s ROE, which measures how effectively the bank is generating profits from the capital that shareholders have put in the company, has been increasing steadily from 9.28 percent in 2016 to 9.47 percent in 2019. To date, MBT’s ROE is considered one of the highest in the industry, which is way above industry average of 8.9 percent.
MBT’s ROA, on the other hand, which measures how well the bank utilizes its assets in terms of profitability, has also been increasing from 0.99 percent in 2016 to 1.2 percent in 2019.
Again, MBT’s ROA is also among the highest in the industry, which has an average return of only 1.06 percent.
MBT also continues to enhance its productivity and operational efficiency. Its efficiency ratio, which measures how management controls their overhead expenses, has been improving from 55 percent in 2019 to 50 percent last year.
The ability of MBT’s management team to improve its returns and efficiency ratios consistently mean stronger shareholder value in the long-term.
4| Know the intrinsic value of the stock
In general, it is not easy to value a bank stock because estimating its cash flows from its risk assets are difficult to do.
But by assuming net income as free cash flows after deducting dividends, we can value Metrobank’s stock using the Discounted Cash Flow (DCF) method.
If we assume that MBT’s earnings will grow conservatively by only six percent over the next 10 years and the long-term GDP growth at five percent, we will derive MBT’s DCF value per share at P88.9 per share.
We computed this by using MBT’s discount rate of 8.20 percent, which is based on prevailing 10-year bond yield plus premium.
At P88.9 per share, current share price offers potential upside of 72 percent over the long-term. This will also put MBT’s Price-to-Book Value (PBV) ratio at par at 1.2 times.
However, if we want to play conservative given the persistent risks of a slowing economy due to the effects of pandemic, we can assume GDP will grow only by three percent over the next 10 years.
Under this assumption, we can derive a lower DCF value estimate for MBT at P62.7 per share, which offers 21.5 percent upside at current market price of P51.6 per share.
5| Know the long-term value of the stock
The other way to estimate the value of Metrobank is by the use of an investment strategy approach often used by legendary investor Warren Buffett.
According to Buffett, he prefers businesses that he can predict what they’re going to look like in 10 to 15 years because companies that can grow consistently with a fair degree of certainty can deliver superior returns in the long-term.
We use this approach by first taking the average return on equity of MBT for the past 10 years, which is 11.2 percent. We then multiply this against its average retention ratio of 82.2 percent to derive the sustainable growth rate of 9.2 percent.
Using the growth rate of 9.2 percent, we compound the future book value of Metrobank stock for the next 10 years from P72.10 per share in 2020 to P174.5 per share by 2030.
If we multiply the future book value of MBT on the 10th year by the bank’s average ROE of 11.2 percent, we will derive target earnings per share of P19.6 per share.
Assuming the market will price MBT at its historical PE average of 10.5 times, we can derive a long-term price target at P207.7 per share for the stock after 10 years.
In order to have an idea of how much MBT will be worth today, we can simply discount to its present value, which is at P96.8 per share.
Now, remember we assumed MBT’s average ROE at 11.2 percent. If we use the current ROE of MBT at 9.5 percent keeping all other assumptions unchanged, we will conservatively derive the long-term price target for MBT at P153.9 per share.
Again, if we discount this price at today’s risk, we will derive a price target of P70 per share, which is roughly equal to the bank’s book value per share.
Henry Ong, RFP, is president of Business Sense Financial Advisors. Email Henry for business advice [email protected] or follow him on Twitter @henryong888