Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Michael Makdad. He is an equity analyst at Morningstar. Hello.
Michael Makdad: Hi. Thanks for having me today.
Black: So, Michael, you cover banks in Japan and Korea. What are some of the things to like about banks in this area?
Makdad: Well, both in Japan and Korea, although the sectors are quite different based upon the countries' different economic situations, both of these countries, the banks are very low valuations, and that's been the way for a while. So, in terms of what do we mean by low, we're talking about for the Japanese three megabanks, they traded about 0.5 times book, and then for the Korean banks, they've traded lower than that. I think they've recently recovered somewhat, but they're still 0.6 times or lower to book value. So, I think the low valuation is one of the – and relatively high dividend yields is the attraction.
Black: So, I think for global investors, inflation picking up is a big theme at the moment. How does that affect these banks?
Makdad: So, for Japanese banks, inflation is the one thing that basically Japanese domestic stocks and banks and financial stocks in particular have been waiting for basically forever. So, if the globally we can move to a higher inflation regime, that's exactly what could be a catalyst for getting out of very low valuations for a long period of time. Now, that said, although we've seen some inflation starting to pick up, say, in the U.S. and a lot of other places, it will take more to get to Japan to move into basically not deflation. So, recently, I increased my fair values on Korean banks because I do expect net interest margins to widen in 2022 and 2023. But for Japanese banks, unfortunately, I still expect net interest margins to continue to decline, and we don't really see inflation picking up in Japan just quite yet.
Black: But one hot topic for Japan this summer is the Olympics, which obviously got cancelled last year. Do we think it's going to go ahead?
Makdad: Yes, I mean, now I can say that. I think somebody was asking me this, say, three or four weeks ago, and I was like, can you wait a few weeks. But I think now we can say that it's very likely the Olympics will go ahead. I think the mood among the public has shifted a bit. And the political incentives, certainly Prime Minister Suga, but other, basically, the Japanese ruling party, the incentives now are to go ahead with the Olympics and just make sure that – I think it will be a success as long as nothing big major goes wrong. So, make it a success by having nothing major go wrong.
Black: Okay. So, I'll bring it back to the banks now. What are a couple of your top stock picks in the sector?
Makdad: Okay. So, among the largest three Japanese banks, which are called the megabanks, I think a lot of investors will tend to look at Mitsubishi UFJ, which is the largest and the most global, has large Southeast Asian franchises. But among the top three Japanese banks, my top pick has long been SMFG (8316), which is kind of the number two bank. And the reason is, is that it's a bit more cost efficient in Japan, but I think even, say, in the US than MUFJ, and it's had a good track record of increasing dividends. I think MUFJ has also done so, but I think SMFG has been more aggressive about it. And also, I think its business mix within Japan and globally is just a higher profitability one. So, that's been my top pick among the major banks.
Now, also in Japan, although I've long preferred SMFG among the top three, I've recently turned positive also on a somewhat smaller bank called Sumitomo Mitsui Trust Bank (8309), and that's just been in the last month and that's because Sumitomo Mitsui Trust did something that's rather surprising I think people have been waiting for, for a while in Japan, and it was the first bank to do it. And what it was, was that Sumitomo Mitsui Trust Bank said that it's going to reduce its equity cross shareholdings to zero. So, these are large shareholdings in other basically industrial corporations, and it's a drag on banks because it ties up a lot of capital and it prevents them from increasing dividends as fast as they otherwise would. So, Sumitomo Mitsui Trust Bank was the first bank to come out and say it's going to go for zero of these, and it's going to accelerate the pace of their sales.
Black: Fantastic. Michael, thank you so much for your time. For Morningstar, I'm Holly Black.
