Sumitomo Mitsui Financial Group, Inc.

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 4/5

A Japanese financial institution providing a wide range of financial services, including commercial banking, leasing, asset management, and securities brokerage.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Sumitomo Mitsui Financial Group (SMFG) is a diversified financial services group headquartered in Japan, and its operations are influenced by both global and local economic trends and regulations. Understanding its specific moat is made difficult by the complicated nature of its various segments. The bank’s moat rating is a 2/5 because its competitive advantages are limited and not very durable.

Detailed Explanation of the Business

SMFG operates across various segments, each with unique revenue streams and profit drivers:

  • Wholesale Business Unit: This segment provides a comprehensive suite of financial solutions to large corporate clients. Revenues primarily come from lending, investment banking, and advisory services. This division is vital to the group, and its health is heavily reliant on global economic activity and corporate investment.
  • Retail Business Unit: This division serves individual customers and small to medium-sized enterprises, with revenue derived from consumer lending, mortgages, wealth management, and payment services. Consumer spending habits, as well as financial literacy programs in Japan and economic conditions, drive this segment.

  • Global Markets Business Unit: This is SMFG’s trading arm, which includes sales and trading of various financial products including FX, bonds, equities, commodities and derivatives. Trading income is extremely volatile, highly dependent on market forces. This segment is also subject to regulations from both Japanese authorities and international bodies.

  • Other: This category encompasses non-core operating activities, including the head office and other business segments, and includes things such as management fees, income from investment properties, and other small businesses, with relatively minor contribution to overall profits.

Overall, SMFG’s revenues are primarily driven by interest income from its lending operations (which is vulnerable to rising interest rates), fee and commission income from various services (which may vary based on demand for those services), and volatile trading income. The bank’s profitability depends on its ability to manage its costs and generate returns on invested capital across its diverse operations.

Industry Trends and Competitive Landscape:

  • The global banking industry is facing increasing regulatory scrutiny and pressure on capital adequacy. Additionally, global economic and political instability has introduced challenges and uncertainty to financial markets, negatively affecting trading income.
  • Emerging markets, particularly in Asia, represent strong growth opportunities but come with higher risks and potential difficulties in navigating legal structures and regulatory frameworks.
  • The competitive landscape is intense, with a mix of local Japanese banks, global financial giants, and emerging fintech companies all seeking to capture market share. Competition is intensifying in areas like payments and wealth management.

What Makes SMFG Different?:

  • SMFG boasts one of Japan’s strongest balance sheets and has a large domestic branch network.
  • The group has established a substantial international presence, notably in Asia, helping its growth in emerging markets.
  • SMFG has an established reputation for client relationships, and has had a proven record in managing risk and liquidity through various economic cycles.

Financials Deep Dive

The following information is derived from Sumitomo Mitsui Financial Group’s most recent earnings call and filings.

Revenue: The earnings release shows net interest income increasing year over year and reaching 460.6B yen, net fee and commission income was around 370 billion yen for the first 6 months and net trading income reached 177 billion yen. There was total revenue of 4748.2 billion yen up YoY but the expenses were up as well. Operating income was 1164 billion, net profit attributable to owners was 676.6 billion and basic earnings per share was 259.14 yen. There were 2363.4 billion in provisions for credit losses in the first 6 months as well.

Return on Equity (ROE): The bank’s return on equity (ROE) was 12.4% for the quarter which was up from the same time last year but is still a bit volatile and depends on market conditions. The bank is committed to growing ROE through better profitability by expanding into markets with higher profit margins. This is not really a competitive advantage.

Return on Invested Capital (ROIC): The return on invested capital (ROIC) has been volatile based on changing market conditions, as well as changes in economic activity.

Capital Adequacy and Liquidity: SMFG has a solid capital base, with a tier 1 capital ratio of 14.85% and a Tier 1 risk weighted capital ratio of 11.46% as of March 2022. The leverage ratio of 5.5% shows low amounts of debt. Its cash positions are also quite strong, with over ¥17 trillion in cash and deposits with banks. These figures signify the bank’s resilience and ability to manage risk effectively.

Credit Quality: The bank has large amounts of provisions on credit losses that has nearly doubled YOY (2363B Yen), and has a high focus on risk management.

Recent Concerns: Some of the major recent concerns of SMFG are as follows, they are mostly tied to global macro factors and high inflation and geopolitical tensions:

  • The group has seen an impairment on bond investments for the first 6 months due to rising interest rates. This is mainly from Japanese and other government bonds. The rising interest rates are a concern and will continue to be for the foreseeable future.
  • The bank also has seen increased provisions on credit losses due to an impending recession.
  • The Japanese economy has shown slow growth over the past few years and the bank’s domestic business is tied to this performance.

Understandability Rating: 4/5

While the basic functions of a bank are relatively straightforward, SMFG’s operations are complex. The global nature of its operations, its multiple business segments and the variety of financial products offered by this business make this a bit harder to understand.

Balance Sheet Health Rating: 4/5

SMFG’s balance sheet is very well-capitalized and has reasonable liquidity, and the amount of debt is low. The bank’s profitability is also consistently good. As such, the balance sheet health rating is quite high.

Moat Analysis

Here’s the breakdown of the moat analysis:

  1. Intangible Assets: SMFG does not have any specific intangible asset that gives it a major advantage over other similar businesses, although, some areas like credit cards and the company brand might add some value. For credit cards, the company already has its network built. But this does not mean they can charge a premium relative to other credit card providers.

  2. Switching Costs: The switching costs are relatively low in this type of business. Moving between banks is usually fairly simple. While some customers can build up a long term relationship with their primary bank, the hassle to move a bank is small.

  3. Network Effects: SMFG benefits slightly from network effects because of a wide number of customers all using the same network of financial infrastructure. However, that benefit is not as much as that gained by other network effects based business.

  4. Cost Advantages: SMFG does not demonstrate a clear cost advantage over competitors. The group might have some advantages in individual segments, but no unique and sustainable cost advantages.

Therefore, the overall moat is weak, at about 2/5.

Legitimate risks that could harm the moat and the business resilience:

  • Economic Downturns: Significant economic downturns, in particular in Japan and Asia, can reduce demand for the bank’s lending and financial services. These factors could also make it harder to get back to the required return.

  • Regulatory Changes: Shifts in regulations in Japan and international financial markets can require SMFG to increase capital requirements or adjust its business model, and affect its competitiveness and profitability.

  • Increased Competition: The financial services industry is extremely competitive and new fintech companies are making it even harder. All incumbents are finding it hard to retain customers and are having to be more innovative in their approach, meaning profits get compressed. This is an ongoing threat.

  • Technological Disruption: The rapid evolution of technology, such as online banking and digital payment systems, can require banks to make huge capital investments that will result in a lower return on invested capital, and also create barriers that will reduce competitive advantage.

  • Geopolitical Uncertainties: Global instability, including trade tensions and political conflicts, can severely impact the value of international investments and reduce trading revenue for banks.

Despite these legitimate threats, the bank appears to be quite resilient, with a strong balance sheet and a robust risk management policy. It has been able to navigate multiple economic conditions, as well as different financial and regulatory environments. Also, even if its moat is weak, it still has a good standing among customers. However, that does not mean it is a truly strong business to be invested in for the long term.