My Thesis
I believe that despite the strong stock price momentum recently and better-than-expected financial results, investors should avoid buying UBS Group AG (NYSE:UBS) stock today due to the risk of erosion of trust among ultra-high-net-worth individuals (UHNWI), potential regulatory changes, non-repeatable gains in some areas, and ongoing Credit Suisse integration challenges. As I see it today, Wall Street perceives any current post-merger difficulties as a one-off event, but I think UBS could be in a prolonged period of deterioration due to the above problems, which may potentially lead to a loss of market share and reduced profitability as wealthy clients seek more secure and discreet banking alternatives elsewhere.
My Reasoning
Firstly, I would like to pay tribute to one of the largest Swiss banks - after a protracted correction lasting several months in 2022, its shares recovered and reached new all-time highs, gaining more than 124% since the bottom in October 2022:
One of the main reasons for this fast and furious growth is the company's financial results, which have recently exceeded analysts' forecasts. I suggest looking at the results for Q1 2024, which were presented at the beginning of May. As I can see, UBS reported a profit before tax (PBT) of $2.4 billion and a net profit of $1.8 billion, demonstrating a significant positive operating leverage, with a 15% QoQ increase in underlying revenue and a 5% QoQ reduction in underlying OPEX. In my opinion, this is precisely what investors were hoping to see after the company took over Credit Suisse. The systematic reduction of operating costs through layoffs and restructuring of the acquired business has proven to be quite effective, in my opinion - we must give the company credit for successfully managing the M&A challenges.
Also, UBS showed continued franchise strength, with net new assets of $27 billion in "Global Wealth Management" and heightened transaction activity across various divisions. This particular division saw a doubling of pre-tax profit to $1.3 billion, driven by increased revenues and reduced OPEX. The Investment Bank also performed well, achieving a positive return on attributed equity of 10%, and the "Asset Management" segment posted solid results due to cost discipline. Non-core and legacy risk-weighted assets (RWA) were reduced by $16 billion, and underlying operating expenses declined by 26% QoQ, reflecting significant cost reduction efforts.
As far as the capital adequacy indicators are concerned, everything looks more than good for UBS: The firm maintained a CET1 capital ratio of 14.8% and a CET1 leverage ratio of 4.9%, with RWA decreasing by $20 billion QoQ to $526 billion, supporting their 2024 capital return targets.
On May 31, 2024, UBS completed the merger with Credit Suisse AG, and the management noted during the latest earnings call that they expect further integration plans to continue into Q2 and Q3 2024. In general, they anticipate these integrations to unlock substantial cost, capital, funding, and tax benefits starting from 2H2024 and extending into 2025 and 2026. UBS also expects to achieve further gross cost savings and capitalize on the synergies from integrating Credit Suisse's operations. The management noted plans to resume share repurchases post-merger, targeting up to $1 billion, with ambitions to continue repurchases in 2025 and exceed pre-acquisition capital return levels by 2026.
So far, the plan to integrate CS's assets and achieve benefits in terms of reducing operating costs and increasing AUM has been effective. However, while UBS has indeed demonstrated robust growth in Q1, I doubt the sustainability of this growth because of a) potential regulatory changes, b) the non-repeatable nature of certain gains, and c) ongoing integration challenges amid possible trust erosion. Let me explain all my points in order.
First, one of my main concerns is the potentially higher regulatory capital requirements. As Johann Scholtz from Morningstar noted in his recent analysis (proprietary source), UBS's management team was unable "to shine any new light on potentially higher minimum capital requirements" from the Swiss regulator, which is a bad sign as I see it. I think the uncertainty surrounding these requirements could limit UBS's ability to return capital to shareholders, despite having significant excess capital above the current regulatory minimum. On June 1, 2024, BNN Bloomberg wrote that new capital requirements, which could impact UBS's ability to return funds to shareholders, "are seen as particularly burdensome" given UBS's unique position as Switzerland's sole globally systemic bank. Sergio Ermotti (the bank's CEO) has indicated that while UBS's capital distribution plans remain unchanged, it is too early to speculate on the full impact of the new regulatory rules which should extend into next year, with full implementation expected by 2026. As an analyst, I believe this represents a significant risk that cannot be ignored or discounted in our analysis. It's crucial to understand that achieving the EU's goals will likely be challenging if tensions and strained relationships with the regulator persist.
Second, while UBS has managed to book net new money inflows in Q1 despite losing ~40% of Credit Suisse's wealth management relationship managers, the initial concerns about client and revenue attrition remain relevant, and the long-term impact on client retention and revenue generation is still uncertain. UBS's noncore unit is unlikely to replicate the $1 billion net gain from selling legacy Credit Suisse positions in future quarters. The Wealth Management business saw a boost from strong transactional fees in Q1, and UBS reported a 9.6% return on common equity tier 1 capital for the quarter, but management maintains that a mid-single-digit return on CET1 is the expected outcome for fiscal 2024. Based on this, I conclude that some positives from Q1, which gave many investors renewed optimism and hope for continued success, were likely one-off events, which can't guarantee sustained growth in subsequent quarters.
Third, a significant erosion of trust among UHNWIs threatens to undermine the very foundation of UBS's business model. The cornerstone of UBS's business model in the past has been its ability to attract and retain the world's wealthiest people, largely due to Switzerland's reputation for banking secrecy and stability. However, recent developments have severely shaken this confidence. Despite the continued positive influx of wealthy individuals to Switzerland, the region is beginning to lag in attracting new clients compared to countries such as Australia, the United Arab Emirates, Singapore, and the United States, according to a recent report by Henley & Partners. I believe that Swiss banking secrecy, once an inviolable pillar of the Swiss banking system, has become virtually obsolete. Increasing scrutiny by the supervisory authorities, international pressure for transparency, and a series of high-profile data leaks have made banking secrecy a relic of the past, in my view. For UHNWIs, the assurance of confidentiality and discretion is of paramount importance - with these guarantees now at risk, many of UBS's wealthy clients may be reconsidering their banking relationships.
Without calling specific names (persons) and only reporting from my own experience (private conversations), I recall at least 2 cases recently where representatives of ultrarich families from the area where I live and work have tried to move their capital from Switzerland to Dubai. If this anecdote actually spreads, it could have dire consequences for UBS. The loss of UHNWI trust directly translates to dwindling assets under management, reduced advisory fees, and a diminished ability to attract new high-net-worth clients. This erosion of its client base strikes at the heart of UBS's revenue-generating capabilities and undermines its long-term viability.
Also, while I was writing this article, news came out on Bloomberg that Alisher Usmanov has sued UBS Europe SE, accusing the bank of sending false reports about his financial transactions to German authorities between 2018 and 2022. As of note, these reports, claiming suspicious activities like money laundering, led to politically motivated investigations against Usmanov, the release states. I think that no matter how paradoxical it may sound, this lawsuit poses significant risks for UBS as the bank is blamed for "breaching client confidentiality and causing undue harm" to Usmanov. Previously, UBS had conducted a thorough review of Usmanov's activities and found no issues, yet still reported unverified suspicions.
If the court rules in Usmanov's favor, UBS could face substantial financial liabilities and further damage to its reputation. In my opinion, the reputational aspect of this risk is the most important - the fact is that Swiss banks, especially UBS, have always been known for their secrecy, and now we are seeing a case of direct cooperation between UBS and the German authorities. I think this news will make waves and possibly scare off many potential HNWIs.
Comparing what's going on with history, Alisher Usmanov's lawsuit against UBS looks like an unprecedented case that promises to set a precedent for the German banking system. It can be compared to the highly publicized case of Leo Kirch against Deutsche Bank, in which the bank's actions led to billions in losses and the collapse of the Kirch Group's media empire. According to Reuters, after the court proceedings, Deutsche Bank compensated Leo Kirch's relatives with €775 million. This time, the same lawyer who represented Mr. Kirch - Peter Gauweiler - will also represent Mr. Usmanov against UBS, so the development of events promises to be interesting.
Despite all the aforementioned risks, Seeking Alpha data shows that Wall Street is still forecasting tremendous recovery and growth in EPS figures for years to come, seeing a CAGR over the next four years of 48.3%, which is substantial:
At the same time, UBS's revenue, according to the consensus of the same analysts, is expected to see strong growth only in one year, specifically in 2024. For the subsequent 3 years, the expansion is projected to be 1-3% annually.
This leads me to conclude that analysts believe the integration of Credit Suisse will yield similar benefits as seen in Q1 2024. However, the risks I mentioned earlier should, in my opinion, temper analysts' enthusiasm regarding these forecasts - it's likely that we will see a downward revision in their projections in the foreseeable future.
Now let's discuss the bank's valuation. UBS currently offers a FWD dividend yield of ~2.63%. Additionally, it plans to resume share buybacks amounting to ~$1 billion, which is around 1% of its current market cap. This suggests a total shareholder return of ~3.6%. According to analysts' forecasts, the dividend payment is expected to drop to 82 cents per share in 2025, equating to a dividend yield of 2.55%. By 2026, this payout is projected to double to $1.58 dollars per share:
This also seems too optimistic to me, especially when we look at the payout estimate for 2026. Given the current risks, the degree of uncertainty should be higher, which makes these forecasts appear dubious. Even if we assume that the current forecasts are correct, the dividend yield of 2.55% in 2025 suggests that UBS may be overvalued today. This is because the stock's average dividend yield over the past decade has been ~4.18% and this average figure has been maintained through many years of very loose monetary policy. Now, with the looming threat of a new round of inflation in Europe and beyond, UBS is expected to pay 163 basis points below average next year - this is where I see the first sign of overvaluation.
Another indication that UBS may be currently overvalued is a comparison of its P/E FY2025 multiple with those of other major banks. If we examine only European banks such as Deutsche Bank (DB), Barclays (BCS), and BNP Paribas (OTCQX:BNPQY), we find that UBS is overvalued by approximately 2 times. When compared to American counterparts like JPMorgan Chase (JPM) or Morgan Stanley (MS), we see an overvaluation of about 10-15%:
Given the projected EPS growth rate, I believe the bank is overvalued by at least 10-15% (i.e., I assume it could be trading at an American P/E ratio based on its growth rates, even though it's a European bank). However, it's important to understand that the risks I point out in today's article could put more pressure on future net earnings per share than analysts currently expect. Consequently, the actual overvaluation could be much higher, which underlines the risk of buying UBS shares at today's levels.
Conclusion
It's obvious that UBS is now in the phase of actively transforming its newly consolidated business, and investors are being forced to overpay for the potential growth that this transformation can bring. However, despite the recent surge in its stock price and its strong financial results in Q1, I recommend against buying UBS stock right now due to several significant risks.
First off, I question the sustainability of UBS's first-quarter growth due to potential regulatory changes, non-repeatable profits and ongoing integration challenges that could undermine the confidence of high-net-worth individuals. Although UBS has attracted new money despite the loss of much of Credit Suisse's wealth management team, the long-term impact on client retention is still uncertain.
I also believe Wall Street analysts' optimistic forecasts for UBS's future profit and revenue growth seem to overlook these risks, which could lead to them being revised downwards soon. I also don't understand why UBS is trading at such a high P/E 2025 multiple. The high growth rates are clearly playing a role here, but again, these projections are based on consensus estimates that probably overlook the risks I mentioned. UBS still looks overvalued even compared to its U.S. peers, which generally have a higher valuation premium.
So, given the significant uncertainty surrounding UBS Group AG and its high valuation, I see no reason to buy this bank at its current price. Over the next few months, I expect its valuation to come under pressure as new updates from the regulator emerge. While I wish the bank all the best, I don't believe it's wise to invest in its shares at the current price. Therefore, despite some positive aspects from Q1 results, I'm giving UBS a "Sell" rating.
Good luck with your investments!
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.
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