UOB's acquisition a big performance driver even as it caps immediate dividend surprises

WITH recovering profitability and the lifting of dividend restrictions last year, the 3 local banks were positioned to surprise investors with higher dividend payouts for FY2021 and FY2022.

Instead, UOB delivered a different sort of surprise last week.

On Jan 14, the bank unveiled plans to acquire Citigroup's consumer banking businesses in Indonesia, Malaysia, Thailand and Vietnam.

The move will potentially put its capital to good use as the pandemic wanes and regional economic activity recovers over the next few years.

It could also reposition UOB in the eyes of investors as a potent regional consumer banking play, and boost the performance of its shares over the next few years.

Under the deal, UOB will pay a cash consideration equivalent to S$915 million plus the net asset value (NAV) of the consumer business as at completion of the transaction.

The consumer business - which comprises unsecured and secured lending portfolios, retail deposits and wealth management businesses - had an aggregate NAV of S$4 billion as at Jun 30, 2021. It generated income of approximately S$500 million in H1 2021.

UOB said the proposed acquisition will be financed through "excess capital". Excluding one-off transaction costs, the transaction is expected to be immediately accretive to its earnings per share (EPS) and return on equity (ROE).

The acquisition will leave a dent in UOB's capital adequacy ratios though. Based on its capital position as at Sep 30, 2021, the acquisition is expected to reduce UOB's common equity tier-1 (CET1) ratio by 70 basis points to 12.8 per cent.

"The effect to CET1 ratio is not expected to be material and will be well within regulatory requirements," UOB said in a statement on Jan 14.

Dividends constrained?

Much like its peers, UOB saw a strong recovery in profitability last year. For the first 9 months of the year, it reported a 37 per cent year-on-year rise in net profit to S$3.1 billion.

This was attributed to rising income amid the improving business sentiment and lower credit allowance.

Yet, UOB reported a CET1 ratio of 13.5 per cent as at Sep 30, 2021 - down from 14.2 per cent as at Jun 30, 2021.

UOB said in its Q3 2021 performance report that its CET1 ratio declined during the quarter because of "strong asset growth and interim dividends for 2021".

UOB said on Aug 4, 2021 that it would pay an interim dividend per share (DPS) for H1 FY2021 of S$0.60 - which was not only higher than its interim DPS for H1 FY2020 of S$0.39 but also higher than its interim DPS for H1 FY2019 of S$0.55.

This came only days after the Monetary Authority of Singapore (MAS) said on Jul 28, 2021 that dividend restrictions on local banks would not be extended. MAS had told local banks the previous year to cap their total DPS for FY2020 at 60 per cent of their total DPS for FY2019.

UOB's interim dividend for H1 FY2021 - which was paid on Aug 27, 2021 - would have amounted to just over S$1 billion in absolute terms, and was equivalent to almost exactly half its net profit for H1 FY2021 of just over S$2 billion.

UOB's dividend policy as stated on its website is that it is committed to a payout ratio of 50 per cent, subject to a minimum CET1 ratio of 13.5 per cent and sustainable financial performance.

It remains to be seen how well UOB performs in Q4 FY2021 and FY2022. And, in the meantime, the bank has stated that it is comfortable maintaining a 50 per cent payout ratio.

Yet, with the acquisition of Citi-group's consumer banking business likely to take a bite out of its CET1 ratio, UOB may have less room than DBS or OCBC to present investors with a dividend surprise for FY2021 and FY2022.

UOB paid a total DPS of S$1.30 for FY2019, and S$0.78 for FY2020.

Targeting higher ROEs

Investors would probably be better served focusing less on UOB's dividend payouts than how it deploys its retained earnings over the next couple of years.

The approximately S$4.9 billion that UOB plans to spend on the acquisition of Citigroup's consumer banking businesses in Indonesia, Malaysia, Thailand and Vietnam is expected to boost its customer base in those 4 markets from 2.9 million to 5.3 million.

On a pro forma basis, the acquisition will enlarge UOB's gross loans and income in those 4 markets by 20 per cent and 40 per cent, respectively. It will also lift UOB's group-wide annual income by some S$1 billion.

UOB has also invested heavily in technology. As a retail customer myself, I can attest to the current UOB TMRW mobile app being far more pleasant to use than its previous iterations.

Spreading its technology platform investment across a significantly expanded pool of customers could lead to markedly higher levels of profitability. Indeed, UOB is targeting to lift its ROE to more than 13 per cent by 2026.

If it succeeds, it would essentially be replicating a feat achieved by DBS. Over the last few years, DBS has managed to improve its profitability significantly and drive its ROEs well above those of its peers.

For the first 9 months of 2021, DBS reported an annualised ROE of 13.4 per cent. OCBC and UOB reported annualised ROEs of 10.4 per cent and 10.2 per cent, respectively.

This has not gone unnoticed in the market. DBS delivered a total return of more than 146.3 per cent during the 5-year period to Friday (Jan 14), making it the best performing component stock of the Straits Times Index (STI).

UOB achieved a total return of 75.8 per cent, making it the 8th best performer of the STI's 30 components. OCBC was in 10th place, with a total return of 59.2 per cent.

The STI itself delivered a total return of 30.4 per cent during the 5-year period.

DBS is currently trading at 1.7 times its book value as at Sep 30. OCBC and UOB are trading at 1.1 times and 1.3 times their respective book values.

If UOB's proposed acquisition of Citigroup's consumer banking business is executed well, it could leave OCBC further behind and give DBS a serious run for its money.