Share price: HKD3.98 (27 Nov 2013)
Target price: HKD4.60
Expect ROE to remain above peers
Making efforts to reduce NIM pressure. Net interest margin (NIM) of Agricultural Bank of China (ABC) revived from 2.7% in 2Q13 to 2.77% in 3Q13, mainly due to the reduction in interbank borrowing and the increase in investment in long-term bond securities. Besides, ABC has maintained the loan-to-deposit (L/D) ratio at 60.2% and the proportion of demand deposits at 52.2% of total deposits in Sep 2013. We believe ABC will continue to improve its asset and liability management to minimize its NIM pressure under interest rate deregulation. We forecast its NIM to be 2.73-2.74% in 2013-14. We estimate that for every 1ppt increase in its L/D ratio, its NIM will widen by 1-2bps.
Rising net fees contribution; stable cost-income ratio. Net fees contribution rose from 18.1% in 9M12 to 19.3% in 9M13, mainly attributed to the new development of cash management, investment banking and bancassurance businesses. We see room for ABC to explore new fee income opportunities in county areas (18.1% net fees contribution in 1H13). We expect the group’s overall net fees contribution to rise to 20% by 2015. Meanwhile, ABC will continue to expand its network coverage in county areas. Still, it will restrict growth in staff costs and general and administrative expenses. We forecast its cost-income ratio to remain stable at 42.5-42.8% during 2013-15.
Stable credit cost; potential impairment charges on investment. Total NPLs increased faster by CNY1.2b QoQ to CNY87.9b (or 1.24% of total loans) in Sep 2013 (+CNY0.8b QoQ in 2Q13). Still, with a high provision-to-loan ratio (4.3% in Sep 2013), ABC’s credit cost fell to 0.51% in 3Q13 (0.58% in 2Q13). We forecast its credit cost to be 0.85-0.97% during 2014-15, similar to 0.9% in 2012. Meanwhile, ABC increased its investment in financial assets to CNY293b in Sep 2013 (57% of which are related to trust products in Jun 2013). We project impairment charges of CNY2.6-3.3b for these assets during 2014-15.
Potential issue of preference shares. Tier-1 CAR remained low at 9.4% in Sep 2013, slightly below the regulatory minimum of 9.5% for 2018. To top up the ratio to 10%, we estimate that ABC needs to issue preference shares amounting to CNY101b in 2014. We estimate this would dilute ROE by 45bps, assuming a net funding cost of 4%.
Initiate with BUY rating. Despite our projection of impairment charges on investments, we expect ABC’s ROE to remain higher than its peers at 18.5-18.8% in 2014-15. Based on a long-term ROE assumption of 17.5% in our Gordon Growth Model (GGM), we derived a target price of HKD4.60, equivalent to a projected Dec 2014 P/B of 1.23x.
Minimize NIM pressure: ABC reduced interbank borrowings and increased investment in long-term bonds in 3Q13. It also made efforts to stabilize its L/D ratio and reduce migration towards time deposits. We estimate that for every 1ppt increase in its L/D ratio, its NIM will widen by 1-2bps.
Diversify into new fee income business: ABC has developed new fee income sources such as cash management, investment banking and bancassurance businesses. We expect its net fees contribution will rise to 20% by 2015.
Highest provision-to-loan ratio: ABC’s provision-to-loan ratio was 4.3% in Sep 2013, the highest among H-share banks. We estimate that it has accumulated excess provisions of CNY218b. This should be sufficient to cover 76% of its special-mention loans (CNY286b in Jun 2013).
Investment in risky assets: ABC had total investment in financial assets of CNY293b in Sep 2013, 57% of which are in trust products in Jun 2013. We project impairment charges of CNY2.6-3.3b for these assets during 2014-15.
A need to issue preference shares: Tier-1 CAR remained low at 9.4% in Sep 2013. To raise the ratio to 10%, we estimate that ABC needs to issue preference shares amounting to CNY101b in 2014. This will result in ROE dilution of 45bps, assuming a dividend yield of 6% and a net return on proceeds of 2%.
Valuation and Recommendations
We forecast ABC’s net profit to grow at a CAGR of 10.5% during 2012-15. Key earnings drivers will be healthy loan and net fees growth, tight costs control and stable asset quality. We forecast its ROE will drop to 18.5-18.8% in 2014-15 (22% in 2012), but still above its peers.
We applied a long-term ROE assumption of 17.5% for ABC in our GGM. This is lower than its historical trough ROE of 20.5% during 2009-12. We derived a target price of HKD4.60 based on the fair Dec 2014 P/B of 1.23x estimated from the GGM. This is slightly above ABC’s historic trough P/B of 0.98x during 2010-12 but comparable to our estimated fair P/B for CCB (1.2x). We initiate coverage of ABC with a BUY rating. Key risks to our rating include significant NIM pressure and rise in the cost-income ratio for the county area business, as well as the ROE dilution from the replenishment of equity capital.
Publish date: 28/11/13