Sunday, March 10, 2019

Trade Action - OCBC



This company needs no introduction.  Recently, I had initiated a position of 900 shares at a price of $11.06 apiece.  This post summarizes my thoughts about investing in this company.

Pros for investing:

Diversified earnings across industry group and geography
Besides Singapore, OCBC operates in Malaysia (OCBC Bank Malaysia) and Indonesia (Bank OCBC NISP).  OCBC also has two brokerage businesses (OCBC Securities and OCBC Sekuritas), though the result of this division is nothing to shout about.  Another affiliate OCBC Wing Hang operates in Hong Kong and Greater China.  OCBC also owns wealth management unit Bank of Singapore, which has seen healthy AUM growth in FY2018.  Lastly, OCBC owns asset manager Lion Global Investors and an 87% stake in local insurer Great Eastern Holdings.  The diversity of earning streams across industry group and geography minimizes the probability of significant loss caused by a single event.

Recent earnings miss is temporary
OCBC reported lower than expected FY2018 earnings ($1.06 against street estimate of $1.11).  This was mainly attributed to unrealized valuation losses and absence of realized gains in the securities portfolio held by Great Eastern Holdings.  It is pretty normal when investments are marked to market, volatility will swing the valuations and thus impact reported earnings.  Warren Buffett had warned about this phenomenon in his 2017 Berkshire Hathaway Chairman's Letter (source).  Judging from the YTD gain in global equity markets, assuming the trend is sustainable through 2019, the securities portfolio should experience a positive rebound in valuation this year.

Share buyback
OCBC has been consistently buying back shares from the open market.  Some investors see this as a positive move, since it reduces the float and increases earnings per share.  However, it can be a double-edged sword when management does it without regard to the intrinsic value per share.  If we use OCBC’s reported NAV of $9.56 (before unrealized valuation surplus)(source) as a yardstick, then management is not purchasing the stock because it is cheap.  It is more likely an exercise to balance out shares issued under its employee share scheme.

Cons against investing:

Lower dividend than peers
Compared to DBS and UOB, OCBC distributes a lower percentage of earnings (payout ratio of 40.6% versus DBS 59.7% and UOB 51.5%).  This is nothing new, and the bank had explained its rationale previously (source).  According to the Business Times (BT), OCBC CEO Samuel Tsien defended the conservative approach against risks on the horizon.  Mr Tsien “feels that the market is going to be a rougher market” (source).  The CEO also denied looking for potential acquisition at the moment.  For a head honcho to go against institutional imperative – of distributing similar payout as its peers and risk a share price decline – either Mr Tsien is not afraid of shareholder activism, or something is brewing for the company that requires significant capital allocation.  I believe we will know in due time.

Dividend scrip option
Contrary to most investors, I do NOT like companies to offer dividend scrip option.  Firstly, it dilutes the shareholding of existing owners who do not wish to participate (either because of odd lot allocation, which makes it harder to dispose the position in the market, or because of cashflow needs).  Secondly, a dividend reinvestment plan is typically offered because the company wants to retain more cash in their coffers.  The question is WHY?  Why is there a need to set more cash aside?  Again, this circles back to my point highlighted earlier.  There may be something – positive or negative – stirring in the undercurrent.

Oil & Gas industry exposure still a drag
OCBC increased its bad debt provision for the oil & gas industry last quarter.  News finally broke in January when crude oil products supplier Coastal Oil Singapore went belly up with US$354 million debt (source).  OCBC Hong Kong unit was owed the lion’s share at US$122.7m.  In a separate BT article, CEO Samuel Tsien highlighted oil exploration had not increased as expected when oil is trading at US$60-70/bbl range.  Vessel charter still remained below breakeven rates by the bank’s repayment requirement (source).  In short, more pain before the bank is out of the woods.

Final Thoughts

Despite my apprehension from the reasons above, I had decided to go ahead with the investment in OCBC.  Of the three banks, DBS is my first preference, but at 12x earnings (OCBC 10x UOB 10x) and 1.3x book (OCBC 1.1x UOB 1.1x), it is still a tad too expensive for me.  Between OCBC and UOB, I see more growth potential in the former.  That said, I won't be adding to my OCBC position anytime soon.  Hopefully, the reason for OCBC management's conservative stance will come to light as time passes.

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