UBS Earnings Confirm My Investment Thesis

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UBS (UBS), the largest Swiss bank, reported the best third-quarter earnings results in a decade. The profit surge allowed the bank to confirm its second tranche of 2019 dividends. The earnings results are particularly impressive now when the banking industry is not going through its best of times. As an investment bank for the rich, UBS is well-equipped to survive the crisis and even flourish in spite of the current economic environment we are all in.

UBS earnings analysis

The bank’s overall performance was quite impressive. Its net profit almost doubled, totaling USD2.1bn. With concern to the bank’s efficiency ratios, they got much stronger. The cost/income ratio was 72.7% in the third quarter, a significant improvement from the figure of 78.5%. The return on CET1 ratio rose from 13.8% to 17.6%, a great achievement, especially for the macro environment we are all in.

The bank’s leverage position was also quite strong, whilst UBS’s CET1 ratio totaled 13.5%. This is particularly good, given the capital reserve for potential share buybacks has been deduced.

Source: UBS – earnings presentation, page 2

The media release shows that the major source of income in the case of UBS is the global wealth management division. Not only is it important in terms of revenue for the bank, but it also enjoyed a major profit rise in the third quarter. The management explains that the Asian and the American divisions delivered the best third-quarter performance on record. In order to achieve this, the bank managed to reduce the global wealth management division’s expenses. The interest rates in the US fell, which was quite a disappointing fact for the bank. However, the surges in lending and trading revenues helped to more than offset the losses from net interest income.

UBS is so successful in Asia that it is listed as private bank number 1 in the region by the value of assets. However, the growth is far from over, in my view. Asia still seems to be a great opportunity and a potential source of more profit gains for the bank. Due to the fact that people’s incomes are steadily rising in this region, the number of potential wealthy clients is rising too.

As I mentioned in my previous article, the global wealth management division is the key to UBS’s success. As can be seen from the diagram below, a lion’s share of the bank’s profits is due to this division.

Source: UBS’s press release, page 6, chart prepared by the author

The asset management and the investment bank divisions also did exceptionally well in the third quarter. The asset management department sold its stake in Fondcenter, thus improving its financial position. However, even if we deduct the proceeds from this sale, we will see that the revenues and profits rose substantially due to a record rise in management fees. The bank’s clients got even more interested in investing and trading. It is for this very reason that the investment bank department’s revenues rose too. The personal and corporate banking division also held up relatively well. The credit loss expenses were highly moderate and only amounted to CHF84m. This, in my view, is due to the fact that the bank is highly conservative and specializes in rich clients.

UBS – other important news

But the good news does not end there. In the earnings release, it was also announced UBS would pay the second part of its dividends in November. Let me remind you that earlier this year the Swiss regulator asked the bank to split its dividends because of the economic uncertainty. The situation has improved somewhat since then. So, the board of directors proposes to pay the second part of the dividend in November. The dividend paid would amount to USD0.365 per share. This means that the bank’s full-year dividend yield is about 6%. This looks quite attractive to me, especially if we compare this to the S&P 500 dividend yield of about 1.70%.

I was also quite pleased with the fact that the board expected to be allowed to buy back some of the bank’s shares in 2021. That is why it has established a USD 1.5bn capital reserve. Just by looking at UBS’s results, it looks clear the bank can afford this.

UBS – competitive position

Earlier on it seemed American banks were much more profitable than their Swiss peers. Until the spring market crash, the US enjoyed much higher interest rates. So, American banks enjoyed reasonably high profitability as opposed to their Swiss peers, which have been suffering from negative interest rates since 2015. But it looks like the Swiss banks have already adapted to the negative rate environment.

If we look at the efficiency ratios and compare them to where they were some quarters ago, we will be quite surprised.

Source: UBS – earnings presentation, page 8

We can see that UBS has already beaten JPMorgan (JPM), the largest and the most profitable bank in the US, in terms of return on CET1 capital.

However, the net income margins of the Swiss giant are somewhat lower than those of its American competitors but not by much.

And how about valuation? For the sake of simplicity, I decided to take Bank of America’s (BAC) and JPMorgan’s, the two largest US banks, price-to-earnings (P/E) ratios and compare them to the one of UBS.

Data by YCharts

The results are quite impressive. It looks like in spite of its great operational improvements, UBS still remains quite a bargain in terms of its P/E ratio.

UBS’s book value per share also rose. In the third quarter of 2019, it was USD15.5 per share, whereas now it is USD16.6. If we take the three banks’ price-to-book ratios, we will also see that UBS is a better bargain in that respect as well.

Data by YCharts

Risks

It is not all rosy for UBS, however. After all, it operates in a cyclical business. The coronavirus crisis is far from over, it seems. There is a risk the loan losses might rise somewhat, whereas many clients’ portfolios might plunge in value as well. However, the bank seems to be quite immune to the problem of corporate bankruptcies and defaults on personal loans. First of all, it is a bank for the rich. Secondly, only a small part of its earnings is due to corporate and personal banking. So, in that respect, the risks are quite moderate compared to many other banks.

Some uncertainty is also present due to the fact that Sergio Ermotti, the bank’s CEO, is leaving UBS on 30 October. He has been serving the financial giant for 11 years. He is to be replaced by Ralph Hamers. However, Mr. Hamers is famous for his interest in high technologies. He believes that digitalizing banks nowadays is extremely important in order to enable them to adapt to low interest rates and political uncertainty. His approach proved highly effective since he managed to bring ING, a Dutch bank, to profitability.

Conclusion

Even though there are macroeconomic and political risks for the banking industry, UBS seems to be in very good shape to survive and even flourish. Its earnings confirm my personal buy rating for the bank. Although it is a highly risky task to set price targets for stocks, I agree with many analysts who think UBS stock has further to run. Whilst the median target price is USD14.77 per share, UBS stock has further to run if nothing catastrophic happens in the near to medium term, I believe.

Source: Money CNN

Disclosure: I am/we are long UBS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.