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Morningstar | Daiwa Securities Reports Weakest Quarter and Year Since Launch of Abenomics

Daiwa Securities reported full-year net profit of JPY 64 billion (ROE of 5.1%) and fiscal fourth-quarter profit of JPY 13.4 billion (annualized ROE of 4.3%), its weakest quarter and year since the launch of Abenomics in early 2013. Yet Daiwa’s results showed much more resilience to a surprisingly tough market environment (the retail securities business was awful industrywide in Japan in the January-March quarter notwithstanding the rebound in global stock prices) than its larger rival Nomura. For Daiwa, its retail, asset management, and wholesale segments all have had zero quarters with losses this year or in recent history, nor did Daiwa have a quarter in which its overseas business posted losses despite ongoing weakness in Europe. We believe this reflects Daiwa’s lower cost structure than Nomura and its business model that is more focused around its core Japanese business.

We continue to expect Daiwa to generate higher return on equity on average than Nomura even though we view Nomura’s core domestic business as moatier than Daiwa’s owing to Nomura’s larger scale and stronger brand name in Japan. That said, we are lowering our fair value estimate for Daiwa from JPY 768 to JPY 635 as we now place fair value around 0.80 times book value (compared with 0.70 times book value for Nomura) based on assumed cost of equity of 8.5% and long-term average ROE of around 7%. We previously expected a long-term average ROE for Daiwa of closer to 8%, but the recent deterioration in the market environment appears to be more than just short-term weakness and we believe Daiwa will need to further cut its already lean costs for its ROE to approach its cost of capital. Fundamentally, we think Daiwa is doing a good job of executing operationally and sticking to its core strengths, but the firm’s ROE potential is limited by the disadvantage of operating against competitors with larger scale, namely Nomura, and the securities units of the mega-banks.