A solid earnings year
We expect 2014 to be a strong year for China banks. Earnings delivery is likely to be supported by the government’s pledge for stable economic growth, while re-rating catalysts could come from increased momentum in economic reforms.
While we are positive on the sector (Overweight maintained), we very much prefer the large state-owned banks over the joint-stock and rural commercial banks. Our top picks are ICBC, CCB and ABC.
A solid earnings year
We expect China banks to deliver 6.9% earnings growth in 2014. Adding this to a 6.2% dividend yield, the sector’s prospective total return is 13.1% (the fourth-highest among Asian banks for 2014). Such returns should be underpinned by our expectation of 13% volume growth (in line with 2014) as the government has pledged stable economic growth. In the absence of a rate cut (not expected) and further deposit-rate liberalisation (probable), net interest margin for the sector should be broadly flat in 2014. Our bottom-up analysis of corporate borrowers’ credit quality supports the view that NPL formation should start to moderate as 2014 progresses, thereby providing further earnings support.
Catalysts from reforms
There remains a significant disjoint between the sector’s earnings delivery and valuations. The sector’s ROA is 1.32% vs. a market-implied ROA of 0.81%. We believe the recent reform blueprint from the CCP Central Committee will be a catalyst for unlocking value in the sector, although this is likely to be gradual. Tax and local-government reform should remove the LGFV overhang. SOE reform should improve borrowers’ credit quality. Financial market reform should increase the total wallet size of the market, benefitting brokers as well as banks. In addition, we think that as the reform momentum gathers pace, the risk premium for Chinese equities should drop, further boosting valuations.
China banks are trading at a weighted average P/BV of 0.9x (FY14) for an ROE of 18.7%. The sector is trading at 5.3x FY14 P/E for 6.9% earnings growth. Dividend yield is about 6.2%. Within the sector, we prefer the large state-owned banks. Our top picks are ICBC, CCB and ABC. We would generally avoid joint-stock and rural commercial banks due to a combination of capital, liquidity, asset-quality and business concerns.