A holding company that owns a bank that owns a bank
Dah Sing Financial Group (DSFG) is Hong Kong based, family-led financial services group. DSFG is the holding company for the group’s general insurance, pension fund and banking business. It holds 74.37% of the listed Dah Sing Banking Group (2356 HK – DSB). DSB in turn owns 14.66% of Bank of Chongqing (1963 HK -BOCQ) , a Mainland Chinese Bank. DSB is active in retail and commercial banking.
My experiences with banking in Hong Kong as a customer are horrible. Simple transactions which can be done from your phone in other countries require a lot of paper and patience. Opening a corporate bank account is practically impossible. I do notice however that there is a bit of improvement lately. Recently the HKMA granted 8 virtual bank licenses. This should shake things up a little. I find it hard to say if this will have a positive effect on banks margins or this will open up more competition between the banks. I would think the latter. So far the relatively small size of the market creates a bit of a niche market I think. Besides the big Chinese banks, HSBC and Standard Chartered there are not many other international banks active here.
Fundamental Valuation
To me, a bank is very much a black box. Earnings at a bank are heavily based on estimates which are very hard to verify. While the valuation might be hard, that does not mean we should shy away from trying. Also, precise valuation is not that important anyway when the margin of safety is big enough.
DSFG owns 74.37% of DSB, which translates (at 11.58 HKD per share of DSB) into a value of 37.88 HKD per share. Besides the banking subsidiary, you would also buy into a general insurance business with around 7.75 HKD per share in net assets. This insurance business generated only around 50m HKD in the first half of 2019 but it is growing very fast.
In 2017 DSFG sold its life Insurance business for 8B HKD. Only 2.2B HKD was paid out as a special dividend. 1.5B was used for in the general insurance business and a little more than 4B was used to strengthen the capital base and applied to working capital. So even if the insurance business is not worth the full 7.75 HKD, there is quite a bit of excess cash on the balance sheet which would make an intrinsic value of 45 HKD very conservative.
The next question is how does the market price of DSB stack up against its intrinsic value. Adjusted earnings per share in the last five years were between 1.48 and 1.77 HKD per share (in a steady uptrend). At a current PE of 6.76 and a price to book value of 0.61, valuation seems to be undemanding. One word of caution is that the stake in BOCQ is on the books at 3.9 billion HKD while the current market value of the stake is 2.1billion HKD. DSB uses the “Value in Use” method to account for its stake in BOCQ and has been steadily writing down its book value. BOCQ can be bought at a 3.3 PE and a 0.42 PB ratio. This current market valuation certainly seems to be very cheap for a 14%+ Return on Equity Bank. On first sight, the bank does not take excessive risks but I did not perform a whole lot of due diligence on it.
Historical valuation
For the historical valuation I prefer to look at DSB rather than DSFG because DSFG has materially changed because of the sale of its life insurance business. It does not change the conclusion. As you can see in Graph 1, the Price-to-Book ratio is approaching levels we saw during the Great Financial Crisis while returns-on-equity are around 9-10%
Risks
- The trade war and the political unrest are wreaking havoc on the Hong Kong economy. This would cause lower volume growth and lower Net Interest Margin. This already showed up in the latest Half year earnings. Non-interest Income will also suffer under worse market conditions.
- If Hong Kong would lose its status as an international finance center, there might be a capital flight. This would cause a collapse of the economy and DSB would get stuck with a lot of soured loans and collateral which might be worth a lot less than initially estimated.
- Disruption from virtual banks.
Conclusion
Dah Sing Financial Group is a well-run financial services group which, due to sentiment, is priced as if we are in the midst of a financial crisis. It has survived the Asian Crisis, the Great Financial Crisis and it is conservatively managed. Capital ratios and Equity-to-total assets all are very prudent. DSFG has excess cash and in case of need can recapitalize the bank easily. Buying shares around 30HKD gives me an estimated yield of around 20%.
