Share price: HKD3.74 (27 Nov 2013)
Target price: HKD4.30
A dark horse
A key beneficiary of QE tapering. Bank of China (BOC)’s net interest margin (NIM) remained below its peers at 2.21% in 3Q13 (2.22% for 9M13). This was mainly due to the low-margin domestic foreign currency business (NIM: 0.94% in 1H13) and overseas business (NIM: 1.25% in 1H13). The HK dollar and US dollar average interest earnings assets accounted for 20% of group total in 1H13. We expect the QE tapering will result in a steepening US dollar yield curve with minimal interest rate volatility. This should provide opportunities for BOC to enhance its NIM through lengthening the duration of its HK dollar and US dollar assets. We estimate that for every 10bps increase in the yield of these assets, BOC’s NIM will widen by 2bps. Overall, we forecast the group NIM of BOC to stay at about 2.2% during 2013-15.
Robust non-interest income growth. Net fees grew robustly by 31.0% YoY in 1H13, mainly driven by agency commissions, bank cards as well as consultancy and advisory fees. Besides, BOC’s insurance business reported strong growth in premium income of 62.4% YoY for 1H13. It also recorded client-driven net trading income growth of 10.4% YoY for precious metal products for 1H13. We believe BOC will actively diversify into non-interest income businesses to compensate for its lower-than-market-average NIM. We expect its non-interest income to grow faster than its peers at a CAGR of 15% during 2012-15.
Lower credit cost than peers. Total NPLs increased slower by CNY2.6b QoQ to CNY72b in Sep 2013 (NPL ratio of 0.96%; +CNY3.1b QoQ in 2Q13). Still, it maintained the provision-to-loan ratio for its domestic business at 2.63% in Sep 2013. Even under our conservative assumptions on new NPLs, we forecast BOC’s credit cost will remain lower than its peers at 0.59-0.63% during 2014-15 (0.29% in 2012).
Potential issue of preference shares. We forecast BOC’s tier-1 CAR will drop to 9% by end-Dec 2014, below the regulatory minimum for 2018. To top up the ratio to 10%, we estimate that BOC may issue preference shares amounting to CNY100b in 2014. We expect this will result in ROE dilution of 40bps, assuming a net funding cost of 4%.
Initiate with a BUY rating. With the projections of higher credit cost, we forecast BOC’s ROE will drop to 16.2-16.3% in 2014-15 (18% in 2012). Based on a long-term ROE assumption of 15% in our Gordon Growth Model (GGM), we derived a target price of HKD4.30, equivalent to a projected Dec 2014 P/B of 0.95x.
Room to improve NIM: The HK dollar and US dollar average interest earnings assets accounted for 20% of group total in 1H13. BOC could enhance its NIM by lengthening the duration of its HK dollar and US dollar assets. We estimate for every 10bps increase in the yield of these assets, BOC’s NIM will widen by 2bps.
Rising net fees contribution: Net fees contribution rose to 21.4% of total income in 9M13 (20% in 2012). We believe BOC will actively diversify into new fee income businesses, such as bancassurance and offshore RMB business. We forecast its net fees contribution will rise to 23-24% during 2014-15.
Asset quality remained in good shape: Total NPLs increased slower by CNY2.6b QoQ to CNY72b in Sep 2013. BOC maintained its provision-to-loan ratio for its domestic business at 2.63% in Sep 2013. We forecast its credit cost will remain lower than peers at 0.59-0.63% during 2014-15.
Higher loan-to-deposit ratio than peers: Domestic RMB loan-to-deposit ratio edged up to 71.3% in Sep 2013 (70.2% in Jun 2013) due to slower growth in domestic RMB deposits (+0.6% QoQ in 3Q13). This may restrain its RMB loan growth in the coming years.
Potential ROE dilution from capital replenishment: We forecast BOC’s tier-1 CAR will drop to 9.1% in Dec 2014. BOC may need to issue preference shares amounting to CNY100b in 2014. We expect this will result in ROE dilution of 40bps, assuming a dividend yield of 6% and a net return on proceeds of 2%.
Valuation and Recommendations
We forecast BOC’s net profit to grow at a CAGR of 7.6% during 2012-15. Key earnings drivers will be strong net fees growth and tight cost control. We forecast its ROE to fall 16.2-16.3% during 2014-15 (18% in 2012).
We applied a long-term ROE assumption of 15% for BOC in our GGM. This is higher than its historic trough ROE of 14% during 2006-12. We derived a target price of HKD4.30 based on the fair Dec 2014 P/B of 0.95x estimated from the GGM. This is also higher than BOC’s historic trough P/B of 0.72x during 2006-12. We initiate coverage of BOC with a BUY rating. Key risks to our rating include the narrowing in NIM of the domestic foreign currency business and ROE dilution from the potential equity capital replenishment.
Publish date: 28/11/13