Japan bank shares attractive on earnings outlook

Mon Jun 25, 2012 12:47am EDT

Related Topics

* Banks' earnings momentum rises in June, Topix falls

* Banking sector offers lower 12-month forward P/B

* But shares still vulnerable to Europe event risks

By Dominic Lau

TOKYO, June 25 (Reuters) - Japanese banking shares, hit by worries about the impact of Europe's woes despite the lenders' limited exposure to the region's troubled debt, offer a good investment opportunity as the sector's earnings momentum improves further, analysts said.

Japan's big banks - Mitsubishi UFJ Financial Group, Mizuho Financial Group and Sumitomo Mitsui Financial Group - are also expected to benefit from their overseas expansion, though they still face sluggish loan demand in their home market.

The sector's one-month earnings momentum - analysts' earnings upgrades minus downgrades as a total of estimates - has risen to 19.7 percent from last month's 7.8 percent, Thomson Reuters Datastream data showed.

In contrast, the broad Topix index's earnings momentum has turned negative, to minus 2.3 percent from 0.1 percent in May.

"The argument is pretty clear. Banks around the western world have a lack of capital, are loaded down with subprime, with exposure to the European bond market and so on," said Nicholas Smith, a Japan equity strategist at CLSA.

"The Japanese banks (shares) are pretty much moving in lockstep with those western banks and yet they don't have those problems. They are actually overcapitalised ... Their earnings line is much cleaner because it is coming from utility earnings rather than casino earnings."

Japan's banking sector also offers cheaper valuations, with a 12-month forward price-to-book ratio of 0.53, versus the Topix's 0.83, although its return on equity of 7.1 percent is lower than the index's 7.7 percent, Datastream data showed.

Japanese bank shares have advanced 7 percent so far this year, outpacing a 3.1 percent rise in the Topix.

RISKS REMAIN

Bank of America Merrill Lynch said in a report last week that credit risk on Japanese banks' balance sheets was "extremely low".

"While the stock prices should continue to be affected by euro zone factors, we believe the Japanese banks fundamentally offer good value and should be less affected by such global concerns, with assets risks quite low and solid growth possibilities supported by business expansion in the U.S. and Asia," Merrill Lynch said.

Its top pick among banks was Sumitomo Mitsui Financial, while Mitsubishi UFJ Financial, which has a stake in Morgan Stanley, was the most sensitive to overseas conditions, it said.

Still, the sector remains vulnerable to any event risks in Europe, and should Spain's financial position and the health of its banks continue to deteriorate, Japanese lenders would again come under selling pressure.

"(Last week bank) share prices simply advanced on a change in investor expectations," Barclays Capital said in a research note.

"On the other hand, the market actually remains cautious, as seen in sustained high yields for Spanish debt, and we think bank stocks that recovered over the past two weeks might slip again."

At home, Japanese lenders are also plagued by weak loan demand as businesses and households stay reluctant to spend in Japan's fragile economy, putting the banks under further pressure to expand overseas.

The top three banks enjoyed strong profits in the financial year that ended in March, but much of the boost was due to hefty gains from trading in Japanese government bonds. (Editing by Chris Gallagher)

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