Sumitomo Mitsui Financial: A Bright Future Ahead (Rating Upgrade) (NYSE:SMFG)

Elevator Pitch

Sumitomo Mitsui Financial Group, Inc. (NYSE:SMFG) [8316:JP] shares are assigned a Buy rating.

I previously touched on SMFG’s shareholder capital return, financial goals, and valuations in my December 10, 2023 article. This current update highlights the latest positive developments for Sumitomo Mitsui Financial.

My view is that Sumitomo Mitsui Financial has a bright future ahead which justifies an upgrade of my rating for SMFG from a Hold to a Buy. This takes into account the high likelihood of a rate hike for Japan materializing in the coming months, and the growth outlook for Japan’s asset management industry.

Company Can Capitalize On Growth Opportunities In Asset Management

At the beginning of February 2024, Sumitomo Mitsui Financial issued an announcement disclosing its Q3 FY 2024 (YE March 31, 2024) financial results. SMFG’s top line and net income grew by +22% and +11% to JPY909 billion and JPY266 billion, respectively for the most recent quarter. More significantly, the company’s latest third quarter revenue and net profit came in +9% and +21% (source: S&P Capital IQ) above the consensus financial estimates, respectively.

The main driver of SMFG’s above-expectations performance for the recent quarter was the +18% YoY growth in its net fees and commissions to JPY371 billion in Q3 FY 2024. There is a good chance of Sumitomo Mitsui Financial increasing its fee income going forward with its plans to transform into an “asset management solution provider” as detailed in the chart presented below.

SMFG’s Plans To Offer Asset Management Solutions

The Japan Times reported on February 19, 2024 that Japan has recently initiated favorable changes for the country’s “tax-free investing program for households” referred to as “the Nippon Individual Savings Account (NISA), by raising the annual investment cap.” The key changes for NISA are highlighted below.

Key Changes To NISA

It is reasonable to assume that the growth outlook for Japan’s asset management industry has become more favorable with the recent changes made to NISA.

As one of the leading financial services companies in Japan, Sumitomo Mitsui Financial Group is well-positioned to capitalize on asset management-related growth opportunities by providing relevant asset management solutions as highlighted above. In specific terms, SMFG’s goal is to more than triple its number of NISA clients’ accounts from the current 1.59 million to 5.1 million in four years’ time.

SMFG Will Be A Beneficiary Of Potential Rate Hike For Japan

SMFG’s Q3 FY 2024 financial performance would have been even better, if not for a sequential contraction in net interest income. The company’s net interest income decreased by -3% QoQ to JPY455 billion in the third quarter of fiscal 2024, which it attributed to a higher “deposit funding cost” for markets outside Japan in its earnings presentation slides.

Looking forward, Sumitomo Mitsui Financial’s net interest income growth prospects are favorable.

Nomura’s (NMR) economists hold the opinion that “the BOJ (Bank of Japan) will likely abandon NIRP (Negative Interest Rate Policy) and YCC (Yield Curve Control) in April 2024.” NMR’s view is backed up by recent comments from BOJ’s governor. A February 22, 2024 Reuters news article cited Kazuo Ueda’s (BOJ’s governor) latest remarks that Japan’s “inflation was accelerating” which boosted BOJ’s “conviction that conditions for ending negative interest rates were falling into place.” It will be realistic to think that there is a rate hike for Japan on the cards.

Japan’s current policy rate is -0.1%. SMFG estimates that its net interest income could potentially increase by +JPY42 billion when the policy rate goes from -0.1% to 0%, as indicated in the company’s recent quarterly results presentation slides. Sumitomo Mitsui Financial also forecasts that the company’s net interest income might grow by another +JPY35 billion if the policy rate is raised further from 0% to 0.1%.

Sumitomo Mitsui Financial’s actual net interest income for the first nine months of fiscal 2024 was JPY1,343 billion, which translates into an annualized net interest income of approximately JPY1,790 million. This implies that a potential rate hike (up to policy rate of 0.1%) can potentially boost SMFG’s net interest income by around +4.3%.

Updated Valuation Analysis Points To Meaningful Upside

I provide an update of my valuation analysis for SMFG after considering its positive outlook relating to net interest income and asset management fee income growth as detailed in the previous sections of the article.

In my December 2023 write-up, I noted that “the Gordon Growth Model calculates the P/B ratio as ROE minus perpetuity growth rate divided by the cost of equity minus perpetuity growth rate.” My updated ROE, perpetuity growth rate, and cost of equity assumptions are 8.5%, 2%, and 8%, which translates into a target P/B multiple of 1.08 times for Sumitomo Mitsui Financial.

My prior ROE and perpetuity growth rate assumptions as per my December 10, 2023 article were lower at 8.0% and 0%, respectively. As mentioned earlier in this article, SMFG’s financial prospects have gotten better taking into account the asset management-related growth opportunities and the potential for a rate hike. Also, my earlier 10% cost of equity assumption seems to be too high, as other research analysts are assuming a cost of equity in the 8%-9% range for Japanese banks. This explains why I have changed my cost of equity assumption to 8%.

As per S&P Capital IQ’s valuation data, Sumitomo Mitsui currently trades at a trailing P/B ratio of 0.77 times. As such, a target P/B metric of 1.08 times is equivalent to a 40% upside for SMFG.

Closing Thoughts

The market is now valuing SMFG at a meaningful (more than 20%) discount to book value. In contrast, my analysis of the company’s outlook and the stock’s valuation indicates that Sumitomo Mitsui Financial deserves to trade at above book value. I have turned bullish on SMFG after considering recent favorable developments for the company.