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KB Financial Group Is Undervalued

- By Mark Yu

After writing about South Korea's largest company, Samsung Electronics (SSNLF), finding the next undervalued gem among the companies in the $1.38 trillion economy, as per gross domestic product, should be worthwhile.


KB Financial Group (KB) (105560.KS) was among the lowest trading earnings multiple browsing through the largest South Korea ETF - iShares MSCI South Korea Capped ETF (EWY) - with $3.14 billion assets.

Valuations

The $17 billion South Korean bank is markedly undervalued compared to its peers. According to GuruFocus data, KB Financial had a trailing price-earnings (P/E) ratio of 8.9 times (industry median 14.3), price-book (P/B) ratio of 0.6 times (industry median 1.2) and price-sales (P/S) ratio of 2.14 times (industry median 3.3).

KB Financial had a trailing dividend yield of 2.64% with a 19% payout ratio and 52.2% five-year growth rate, according to Reuters data.

Earnings performance

KB Financial delivered its preliminary operating results for fiscal year 2016 early in February. According to information gathered from KB Financial's FactBook for fiscal 2016, gross operating income - net interest income including net fee and commission income and other expenses - grew 0.85% to 7.44 trillion South Korean won ($6.4 billion). Despite the near flat overall business growth, profits attributable to KB Financial shareholders grew 26.2% to 2.14 trillion won.

As observed, the $17 billion South Korean bank recorded a remarkable 378% increase in "net other nonoperating income" for the period to 670.9 billion won, up from 140.5 billion won in 2015 - 646.6 billion won of which occurred in the fourth quarter of fiscal 2016, according to company filings (1). KB Financial noted this growth and stated "thanks to the bargain purchase gains recognized by acquiring stakes in nonbanking subsidiaries."

Total return

KB Financial ADR shares outperformed iShares MSCI South Korea ETF in both short- and long-term periods. The financial firm had one- and five-year total returns of 61% and 3.1%, according to Morningstar data while the South Korea ETF had 19.4% and 0.53% return.

S&P 500 index, on the other hand, outperformed both securities in the long term having one- and five-year total returns of 22% and 14%.

KB Financial Group

KB Financial Group is a financial holding company that was established in September 2008. In June 2016, KB Financial is South Korea's third-largest bank in terms of assets.

KB Financial's main business purpose is to hold shares in companies that are engaged in financial or related services, as well as govern and manage such companies. In December 2015, KB Financial had a customer base of approximately 30.5 million retail customers, which represented over one-half of the Korean population.

KB Financial's consolidated subsidiaries are primarily engaged in the banking business, as well as the credit card business, the financial investment business, the insurance business and other related businesses.

(Factbook, KB Financial Group)

Among KB Financial's several subsidiaries, wholly owned KB Kookmin Bank and KB Securities followed by partially owned (39.8%) KB Insurance carried the most in assets with 307 trillion won, 32.4 trillion won and 29.4 trillion won.

KB Kookmin Bank

The former Kookmin Bank was established by the Korean government in 1963 under its original name of Citizens National Bank and became publicly listed 31 years later.

The bank updated its name by 1995 and changed its operations from a specialized bank to a nationwide commercial bank. Then Kookmin Bank was allowed to engage in lending to large businesses through South Korea's Repeal Act that year.

KB Kookmin Bank's gross operating income dropped 0.3% to 5.7 trillion won in 2016. The bank also delivered a 12.9% loss in profits attributable to KB Financial shareholders - down to 964 billion won from 1.1 trillion won in 2015.

As observed, KB Kookmin Bank's "net other operating expenses" rose by 52%, administrative expenses increased by 12%, and income tax expenses also rose by 6.6%.

KB Kookmin Bank's cash, debt and book value

As of December, KB Kookmin Bank had 14.7 trillion won in cash and due from financial institutions and 30.9 trillion in debts and debentures having a debt-equity ratio of 1.32 times compared to 1.33 times the year-earlier period.

Goodwill and intangible assets were negligible with KB Kookmin Bank's 307 trillion won assets. The bank had a book value of 23.3 trillion won compared to 22.7 trillion in 2015.

(Factbook, KB Financial)

KB Kookmin Bank's net interest margin, return on assets and return on equity

Net interest income is the difference between the revenue that is generated from a bank's assets and the expenses associated with paying out its liabilities (Investopedia).

In 2016, KB Kookmin Bank delivered a net interest margin of 1.61% in December compared to 1.53% the year prior.

Return on assets

Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets (Investopedia).

In 2016, KB Kookmin Bank reported an ROA of 0.31% vs. 0.38% in 2015.

Return on equity

Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.

In 2016, KB Kookmin Bank reported ROE of 4.13% vs. 4.87% in 2015.

Provisions for credit losses and NPL Ratio

The provision for credit losses is treated as an expense on the company's financial statements as expected losses from delinquent and bad debt or other credit that is likely to become a default and unsatisfied (default probability; Investopedia).

In 2016, KB Kookmin Bank's provision for credit losses declined by near 66% to 254 billion won from 742 billion won in 2015.

NPL Ratio

NPL ratio is the ratio of the amount of nonperforming loans in a bank's loan portfolio to the total amount of outstanding loans the bank holds (eHow).

A nonperforming loan (NPL) is the sum of borrowed money upon which the debtor has not made his scheduled payments for at least 90 days. A nonperforming loan is either in default or close to being in default (Investopedia).

In 2016, KB Kookmin Bank had an NPL ratio of 0.74% compared to 1.1% in 2015.

Capital adequacy in Tier 1 and Tier 2 under Basel III

Tier 1 capital

Tier 1 capital consists of shareholders' equity and retained earnings. Tier 1 capital is intended to measure a bank's financial health and is used when a bank must absorb losses without ceasing business operations (Investopedia).

Under Basel III, the minimum tier 1 capital ratio is 6%, which is calculated by dividing the bank's tier 1 capital by its total risk-based assets.

In 2016, KB Kookmin Bank had a tier 1 capital ratio of 14.8% vs. 13.7% in 2015.

Tier 2 capital

Tier 2 capital includes revaluation reserves, hybrid capital instruments and subordinated term debt, general loan-loss reserves, and undisclosed reserves. Tier 2 capital is supplementary capital because it is less reliable than tier 1 capital (Investopedia).

In 2015, the minimum tier 2 capital ratio is 2%.

In 2016, KB Kookmin Bank had a tier 2 capital ratio of 1.48% vs. 2.3% in 2015.

Nonetheless, KB Kookmin Bank still passed the Basel III requirement of minimum total capital ratio - tier 1 and tier 2 - requirement of 8% with 16.3% in 2016.

Overall KB Kookmin Bank contributed 45% or 964 billion won of total KB Financial profits in 2016.

KB Securities

KB Securities' wholesale operation provides optimized solutions and platform to corporate clients, training top-tier research analysts and building an intelligent marketing system. The company also delves in investment products and services.

In 2016, KB Securities sales fell flat to 188 billion won and delivered a profit loss of 93.4 million won compared to profit gains of 47 billion won in 2015.

Parent KB Financial metrics

KB Financial cash, debt and book value

As of December, KB Financial had total cash and due from banks of 17.9 trillion won and had 61.2 trillion won in debts and debentures. The parent company had a debt-equity ratio of 1.96 times compared to 1.69 times in 2015.

Goodwill and intangibles remain negligible as KB Financial had a book value of 31.3 trillion won compared to 28.9 trillion won in 2015.

(Factbook, KB Financial)

KB Financial net interest margin, return on assets and return on equity

In 2016, KB Financial recorded a net interest margin of 1.89% compared to 1.81% in 2015. The firm also delivered an ROA of 0.57% compared to 0.52% the year prior and an ROE of 6.9% vs. 5.9% in 2015.

Provisions for credit losses

KB Financial markedly reduced its provisions to 539 billion won in 2016 from 1 trillion won in 2015.

Capital adequacy in Tier 1 and Tier 2 under Basel III

In 2016, KB Financial had a Tier 1 and Tier 2 ratios of 14.4% and 0.899% totaling to 15.3%. This compares to 13.6% and 1.89%, or 15.5%, in 2015.

Cash flow

(Audit Report, KB Financial)

Nine months into fiscal 2016*, KB Financial Group grew its cash flow from operating activities by 71.4% to 2.14 trillion won. In addition to the good amount of profit growth for the period, KB Financial experienced most of its cash inflow from other liabilities and deposits.

*Consolidated cash flow figures for fiscal 2016 were not retrieved at the time of this writing

Capital expenditures were 250 billion won leaving KB Financial with 1.9 trillion won in free cash flow compared to 1.1 trillion won in the prior-year period.

(20-F and Third Quarter Audit Report, KB Financial)

KB Financial also allocated 45% or 839 billion won in dividends and share buybacks. As observed, KB Financial performed its first buyback activity in recent years secondary to its post-stock swap deal with Hyundai Securities whereby the latter became a wholly owned subsidiary.

On average, KB Financial allocated near 22% of its free cash flow in dividends and buybacks - not often practiced.

KB Financial also allocated 3.3 trillion won in financial and associate investments net proceeds from disposal of the group.

Nine months into fiscal 2016, KB Financial took in 48.9 billion from derivative financial instruments for hedging purposes. The firm also had 2 trillion won increase in debts and debentures compared to 1.36 trillion won in the same period in 2015.

Conclusion

As observed, KB Financial's largest subsidiaries failed to grow their corresponding bottom lines in fiscal 2016. In fact, KB Securities delivered profit loss instead. Meanwhile, it was able to generate enough growth in other profits associated with its other subsidiaries that help the company generate profit growth of a quarter of a percent.

Despite a poor performance, KB Financial demonstrated acceptable capital adequacy - see Tier 1 and Tier 2 discussion. KB Financial, nonetheless, exhibited quite a leveraged balance sheet.

(KB Financial ADR Shares, iShares MSCI South Korea and iShares Core S&P 500, Financial Times)

In February, both Morgan Stanley and JP Morgan upgraded its outlook on KB Financial ADR shares to Overweight.

Meanwhile, there could be a near 58% upside should KB Financial ADR shares trade at book value of 31.3 trillion won or $27.1 billion. Asking for a 20% margin would still indicate a possible 26% upside to at least $52 per KB Financial ADR share.

In summary, investors should still wait for a good pull back in KBR Financial before speculatively investing with a target price of $50 a share given the ADR shares recent run up. KBR Financial is a hold.

Notes

  1. KB Financial's audited financial report for third quarter:



Other nonoperating income includes gain on disposal in property and equipment, rent received and others.

Disclosure: I do not have shares in any of the companies mentioned.

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This article first appeared on GuruFocus.