DBS $40 fair price?

1. $DBS GROUP HOLDINGS LTD(D05.SI)$ DBS was hovering near $30 for several months before it broke through it convincingly to $35 currently. What is causing such a strong surge?

2. I believe the key reason is the looming rising interest rates. We have experienced numerous talks about this but what makes this time different? Inflation. Despite printing money for the last 13 years, inflation has not crept up until Covid did us a favour to disrupt the supply chain. It became a catalyst for inflation to rise.

3. Raising interest rate is almost a sure thing now to curb inflation. The macro environment took a 180 degree turn and banks will benefit from this because their net interest margin would improve - make more profits.

4. It wasn't just DBS stock price going up. $OVERSEA-CHINESE BANKING CORP(O39.SI)$ OCBC has crossed $12 and $UNITED OVERSEAS BANK LIMITED(U11.SI)$ UOB is nearing $30. This tells us that it is a sector-wide effect and not peculiar to just one bank.

5. These Singapore banks have a few tailwinds going for them. Rising interest rate being the foremost advantage, Covid recovery is another good sign. This means that the business climate is improving (as long as inflation doesn't get out of hand) and the default rate would not be as bad as provisioned. The non-performing loan rate would be as usual and the reserves kept for Covid impact could be released for dividends.

6. Recovery would also mean a gradual resumption of travel. Whether tourists spending in Singapore or locals going overseas to spend with credit cards, the banks would take a cut on these transaction fees.

7. The rich are getting richer and it was still true during Covid. Wealth management segment continued to expand in the last two years, powering growth for the three local banks. I don't see this changing anytime soon and in fact, I think this segment will grow even more in the coming years. Singapore proved to be better at handling Covid, this would give confidence for wealthy families in the region to channel more wealth to the country and inevitably the local banks will get a part of it.

8. Property market remains hot and the demand for mortgage loan is likely to maintain at a high level. This is another key segment for the three banks. The unknown is whether the recent cooling measure could impact the demand, I personally don't think so. And if the government will further impose policies to discourage property speculations. If so, this could be muted but I don't see it decreasing.

9. At around $35, DBS is trading at a PB ratio of 1.5, which is at least one standard deviation higher than its 5y average of 1.3. It looks expensive but 5y average is still based on a low interest rate environment. We should take a look at a longer history, prior to 2008 before the interest rate cuts began.

10. UOB KayHian did a PB range for the 3 local banks back to 1991. The average for DBS was still 1.3, not much difference. The difference was more obvious for OCBC and UOB. Both OCBC's and UOB's 5y average was 1.2 but since 1991, it was 1.5. If we take these as references, OCBC and UOB are undervalued based on higher interest rate environment. If the new normal PB average is 1.5, OCBC should trade at $18 and UOB at $36.

11. That said, it is well-known that DBS trades at a premium compared to the other two Singapore banks. The reasons could be aplenty, such as, it has Temasek's backing, it has a lot more deposits where the interest costs are low, issuer of SGD bonds, etc. The entire banking industry's valuation will rebase due to the new interest rate environment. And if OCBC and UOB rebases to PB 1.5 and DBS has a premium over them, a PB of 1.7 for DBS could be a new fair value. That would mean DBS at $40 could be reasonable. It is a paradigm shift.