UBS stock (NYSE: UBS), the world’s largest wealth manager, gained roughly 17% – increasing from about $14 at the beginning of 2021 to around $16 currently, inching ahead of the S&P500, which grew 13% over the same period.
There were two main reasons for this: First, the approval of the $1.9 trillion stimulus package in the U.S. Second, the accelerated Covid-19 vaccination drive in the U.S. and Switzerland. Both of the above factors strengthen the forecasts of a strong economic recovery.
But is this all there is to the story?
Not quite, despite the recent gains, Trefis estimates UBS’ valuation to be around $18 per share – 10% above the current market price – based on a key opportunity and one risk factor.
The opportunity we see is an improved trajectory for UBS’ revenues over the subsequent quarters. UBS full-year 2020 net revenues (revenues less provisions for credit losses) grew 12% y-o-y to $32.4 billion. It was mainly driven by a 27% y-o-y jump in the investment bank division (sales & trading and investment banking businesses) followed by growth in wealth management and asset management units. While the rise in the investment bank was due to higher trading volumes and higher underwriting volumes, wealth management and asset management benefited from growth in Assets under Management (AuM), which increased 14% y-o-y to $3 trillion and 21% y-o-y to $1.1 trillion, respectively. On the flip side, the bank reported a 2% drop in its personal & corporate banking net revenues due to a build-up in provisions for credit losses.
The bank missed the consensus estimates of revenues and earnings in the first quarter of FY2021. While the net revenues grew 10% y-o-y to $8.7 billion, the bank suffered a $774 million loss in the quarter as a result of the default by the Archegos hedge fund. It posted a 7% y-o-y drop in its investment bank division, driven by lower sales & trading revenues, partially offset by growth in investment banking. Notably, the wealth management and asset management businesses continued their growth momentum in the first quarter as well, thanks to the growth in AuM. Further, the personal & corporate banking segment grew 15% y-o-y, due to higher non-interest income and lower provisions for credit losses. That said, we expect the sales & trading, and investment banking businesses to see higher trading and underwriting deal volumes for some more time, before normalizing with recovery in the economic conditions. Further, growth in AuM is likely to drive growth in wealth and asset management businesses in the year. Overall, we expect UBS’ revenues to be around $33 billion for FY2021.
The adjusted net income margin is likely to decrease in FY2021 from 20.2% to 17.5%, due to higher operating expenses. This is likely to decrease the EPS from $1.77 to $1.59 for the year, which coupled with the P/E multiple of just above 11x will lead to a valuation of around $18.
Finally, how much should the market pay per dollar of UBS’ earnings? Well, to earn close to $1.59 per year from a bank, you’d have to deposit about $159 in a savings account today, so about 100x the desired earnings. At UBS’s current share price of roughly $16, we are talking about a P/E multiple of just above 10x. And we think a figure closer to 11x will be appropriate.
That said, banking is a risky business right now. While growth is likely, change in current market sentiment can harm the near-term outlook. What’s behind that?
The bank has a portfolio of around $146 billion in personal & corporate banking loans (as per March 2021 figures). It increased its provisions for credit losses in FY2020 to compensate for the higher risk of loan defaults. Notably, the provisions have seen a favorable decrease over the recent quarters, signaling some improvement in the loan repayment capability of its customers. However, any sudden uptick in the Covid-19 cases or deterioration in the economic conditions can expose UBS to sizable loan defaults. Additionally, worsening of the economic scenario can hurt the asset valuations, negatively impacting UBS’ wealth and asset management businesses. To sum things up, we believe that UBS stock is somewhat undervalued.
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