Shizuoka Financial Group: Cheap Regional Bank But No Positive Catalyst (OTCMKTS:SFGIF)

Investment thesis

Shizuoka Financial Group (OTCPK:SFGIF) is a cheap Japanese regional bank, operating in a relatively vibrant economic area. It is focusing on streamlining operations via a holding company structure, remains well-capitalized, and is aiming to provide and grow stable shareholder returns. Valuations are cheap but without a positive catalyst, we rate the shares as neutral.

Quick primer

Shizuoka Financial Group is one of the largest regional banks in Japan, primarily serving Shizuoka prefecture (located between Tokyo and Osaka) and its surrounding area. It offers services to retail and corporate customers, ranging from banking, securities, lending, and credit cards as well as some limited lending activities overseas. Peers include Chiba Bank (OTCPK:CHBAF), Fukuoka Financial Group (OTCPK:FKKFF), and Concordia Financial Group (OTCPK:CRDIY). Shizuoka prefecture is a relatively affluent region, with per capita income ranking 4th out of 47 prefectures nationwide. There are many industrial companies located in the region, producing the third largest manufacturing output in Japan by prefecture.

Key financials with consensus forecasts

Our objectives

Shares of Shizuoka Financial Group have outperformed notably over the last 12 months. We want to understand the source of this performance and the longer-term outlook for the business.

Recent trading

Results for Q1-2 FY3/2023 were slightly ahead of company guidance, driven by a combination of 1) a decrease in operating expenses and lower credit costs YoY (provision for general allowance for loan losses), and 2) one-time gains in equities. Although stock gains are not sustainable, the company is making some progress in lowering its overhead ratio (60.1% versus 62.0% a year previous), although it is some way off its medium-term target of 55%. On a quarterly basis, Q2 saw credit costs rise QoQ, although this was due to allowances being made as some loans saw their credit ratings lowered. However, the overall loan book remains high-quality with an NPL ratio of 1.05% (page 11).

Shizuoka changed to a holding company structure in October 2022, with the key aim of providing more independence amongst group companies, as well as fostering more communication between the various entities. Management at the holding company level is overseeing cross-selling activities, and although it is early days we believe there are plans for cost efficiencies, particularly in the back office and IT systems. Its key subsidiaries such as Shizugin Credit Guarantee, Shizugin Lease, and Shizugin TM Securities are proactively growing their own businesses without head office involvement.

Q1-2 FY3/2023 domestic loan growth remained low and stable at 3.3% YoY, and whilst this may not look particularly high there is an improvement to FY3/2022 which saw growth of 2.3%. Overseas loans (primarily for Japanese entities located offshore) rose 19.5% YoY, with international activity returning post-pandemic.

One slight negative was the decline in the capital adequacy ratio from 16.08% to 14.25% (under Basel III). The ratio still remains at a comfortable level (above 10.5% is a key benchmark), despite the company having to increase its weighting for risk-adjusted assets, which include strategic shareholdings. These assets are expected to be sold off over time, which will gradually increase capital adequacy over time (with all things being equal).

Outlook

Japanese regional banks are not popular investments either for domestic or foreign institutions, as historically they have offered limited scope in terms of growth potential and shareholder returns. With low net interest margins, lending generally in Japan is a low-margin business (apart from consumer finance). Limitations over growth hence remain, as the domestic loan demand is low for both corporates and individuals. However, the understanding of improving governance and shareholder returns is making some headway, and Shizuoka Financial Group has set a target of 50% for the shareholder return ratio (combining the payout ratio for dividends and buybacks). This ratio has averaged 48% over the last 7 financial years, as the company conducted ad hoc share buybacks.

With a strong capital base and a geographic stronghold in its home territories, this low-risk, low-return business can realistically attract investors with income needs. Dividend payouts (which have averaged 32.3% over the last seven years) are expected to increase gradually with a priority on stability – rather like a government bond but without the current interest rate risk.

Valuation

Consensus forecasts (see Key financials table above) depict low single-digit net income growth into FY3/2024. The shares are in value territory with a current PBR of 0.6x, but the prospective dividend yield is not very high at 2.7%.

Risks

Upside risk comes from the industry consolidation of Japanese regional banks, with the stronger banks gaining greater scale and aiming for geographic expansion. However, this issue has been talked about for the last 20 years with limited progress.

A slow, but steady increase in dividend payouts will be positive for the shares, although any pace of change is likely to be pedestrian.

Downside risk comes from the company’s limited appeal to long-only investors, particularly from overseas, which limits any ability for the shares to perform.

Negative macroeconomic events such as a stock market crash, and recession resulting in increasing loan delinquencies would dent the company’s ability to return cash to shareholders.

Conclusion

Shizuoka Financial Group and its peers of Japanese regional banks are mature ex-growth businesses, but their valuations are cheap, and are aiming to get to grips with improving shareholder returns. Unfortunately, we cannot see any positive catalysts for the shares. Corporate Japan is seeing more shareholder activism, and regional banks could be on the billing – but until then we are happy to wait on the sidelines. We rate the shares as neutral.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.