Company Reports

We retain fair value estimates for Bank of Communications, or BoCom, at HKD 6.0, China Merchants Bank, or CMB, at HKD 48, China Citic Bank, or Citic, at HKD 5.7, and China Minsheng Bank, or CMBC, at HKD 3.6 per H share. For Bank of Ningbo, or BONB, the FVE is CNY 27 per A share. The banks' interim results aligned with our expectations for net profit growth ranging from flat to low single digits in 2024. H shares of these banks appear undervalued, trading between 0.2 times-0.7 times 2024 book value, with attractive dividend yields of 6.5%-8.5%, except for BONB, with 3% dividend yield in A stock market. Despite weak net interest margin, or NIM, for CMB, we favor it due to its superior return on equity, steady dividends, and upside potential if consumer sentiment in China recovers.

China Merchants Bank stands out thanks to its leading position in retail banking and an enviable funding cost advantage, which delivers one of the strongest returns on assets among peers. We expect its well-positioned customer base will allow CMB to deliver above-peer equity return during cyclical downturns.

Driven by improved investor sentiment for China banks with stable dividend payments and a historic property rescue package introduced in May, the Hang Seng Mainland Banks Index rallied over 20% in the second quarter. But it pulled back sharply on profit-taking and investors’ concerns that the easing measures were not sufficient to turn around struggling property sales. H-shares of most China banks remain undervalued, with 2024 price/book modestly increasing to 0.2-0.5 times. Dividend yields remain attractive at 6%-8%. With A-share counterparts trading at a 35% premium to H-shares on average, we expect the regulators’ push for higher and more regular dividend payouts, as well as the expansion of eligible exchange-traded funds on Stock Connect, should gradually narrow the valuation gap for Chinese dual-listed banks. Amid sluggish economic growth in China with no major recovery in property sales and consumer spending anticipated in 2024, we prefer defensive state-owned banks, including China Construction Bank, or CCB, and Industrial and Commercial Bank of China, or ICBC, and leading retail-focused bank China Merchants Bank for stable dividends, strong capital returns, and better earnings visibility.

China Merchants Bank, or CMB, and China Minsheng Bank, or CMBC, reported a deeper year-on-year decline in first-quarter revenue of 5% and 7% versus the 2% and 1% decline in 2023. China Citic Bank’s results were stronger than expected, with revenue increasing 5% year on year, driven by stronger-than-expected growth in fee and investment income, which benefited from falling interest rates. The net profit trend weakened further, with net profit contracting 2% and 6% for CMB and CMBC, respectively, and increasing 0.4% for Citic, year on year.

China Merchants Bank stands out thanks to its leading position in retail banking business and enviable funding cost advantage, which delivers one of the strongest returns on assets among peers. We believe strong returns and competitive advantages endow it with a narrow economic moat.

We retain our fair value estimate on China Merchants Bank, or CMB, at HKD 48 per H share (CNY 45 per A share) after the in-line results, with shareholders' net profits increasing 6.2%, despite total revenue declining 1.4% from 2022. Net interest margin, or NIM, is also in line, contracting 25 basis points to 2.15% from 2022. The positive came from a surprise 13.5% rise in dividends per share, or DPS, that saw dividend payout rise to 35%, up from 33% in 2022, sending the H-share price up 4%. We believe this suggests bank leadership's confidence in its long-term growth and above-peer return on equity. This will mark 10 years of dividend progression, with compound annual growth rate at 12.2%.

China Merchants Bank stands out thanks to its leading position in retail banking business and enviable funding cost advantage, which delivers one of the strongest returns on assets among peers. We believe strong returns and competitive advantages endow it with a narrow economic moat.

Narrow-moat China Merchants Bank’s preliminary 2023 net profit of CNY 146,602 million, up 6.22% year on year, was slightly better than expected, driven mainly by lower provision and operating cost-savings. The results are commendable given persistent revenue challenges resulting from mortgage repricing and regulatory commission rate cuts in bancassurance and mutual fund sales. However, we expect these headwinds to continue in 2024, leading to a low-single-digit contraction in total revenue growth. We cut our 2024 net interest margin projection by 6 basis points to 1.90% and fee income by 15% to CNY 74 billion. Consequently, we lower our fair value estimates for CMB to CNY 45 per A share and HKD 48 per H share, from CNY 50 and HKD 54, respectively. Trading at a dividend yield of over 7% and 2024 forward P/B ratio of 0.6 times currently, CMB’s H-shares are significantly undervalued, but we think the upside may be capped in the near term as it is more vulnerable to sluggish consumption demand and fluctuations in wealth management-related fee income. With no major consumer sentiment recovery in sight, we continue to prefer quality and defensive state-owned banks that we cover in China, with the Agricultural Bank of China and China Construction Bank as our top picks.

China Merchants Bank stands out thanks to its leading position in retail banking business and enviable funding cost advantage, which delivers one of the strongest returns on assets among peers. We believe strong returns and competitive advantages endow it with a narrow economic moat.

The China banks’ cumulative, nine-month net profit growth was largely in line with our expectations, with decent loan growth partly offsetting declining net interest margin and soft fee income. Industrial and Commercial Bank, Bank of Communications, China Merchants Bank, and Postal Savings Bank, saw 0.8%, 1.9%, 6.5%, and 2.4% growth in net profit, respectively, year on year. Agricultural Bank of China reported higher profit growth at 5%, but the improvement was mainly driven by a lower tax rate on higher investment in government bonds. Among the China banks that reported results, Agricultural Bank and China Construction Bank reported steadier net profit growth at 3.1% and 5%, versus 3.4% and 3.5% in the first half, thanks to their resilient loan and fee income growth.

We lower our fair value estimate on China Merchants Bank, or CMB, to HKD 54 from HKD 64 per H-share and CNY 50 from CNY 55 per A-share after we reduce our 2023 net interest margin, or NIM, forecasts by 3 basis points and 2023 fee income growth by 7 percentage points. We push back our original assumptions for consumption growth to stabilize in China in second-half 2023 and incorporate a less optimistic outlook for recovery in consumer credits and the wealth management business as property developer credit risks rise.

China Merchants Bank, or CMB, stands out thanks to its leading position in retail banking business and enviable funding costs advantage, which delivers one of the strongest returns on assets among peers. We believe strong returns and competitive advantages endow it with a narrow economic moat.

Large Chinese banks will release 2023 interim results in late August. We expect that stabilized loan yields after the first-quarter loan repricing, mild consumption recovery, a favorable base effect, and a generally benign credit quality outlook supported by government policies will translate to improved second-quarter growth in both revenue and net profits compared with the first quarter. We expect second-quarter net profit growth to increase by 2 or 5 percentage points to 4% to 9% for six state-owned enterprises from the first quarter’s level, primarily driven by higher revenue growth and lower credit costs.

China Merchants Bank, or CMB, stands out thanks to its leading position in retail banking business and enviable funding costs advantage, which delivers one of the strongest returns on assets among peers. We believe strong returns and competitive advantages endow it with a narrow economic moat.

The Hang Seng Mainland Banks Index has declined 11% from its recent peak in early May. We attribute the decline to increasing concerns about downward pressure on banks’ net interest margins, or NIMs, and growing risks related to debts of local government financing vehicles, or LGFVs, amid a weak economic recovery and struggling land sales. We believe SOE banks have smaller exposures to LGFV debt and that their credit quality is better than peers given strong bargaining power to implement prudent borrower selection. Monetary and fiscal easing and the government’s strong support for troubled regional banks also limit systemic risks, in our view. That said, we believe the ongoing LGFV loan restructuring is likely to weigh on banks’ NIMs and the classification of restructured loans as special-mentioned loans will also increase provision expenses for banks. We maintain our fair value estimates for Chinese banks as we already factored in a NIM reduction of 10-25 basis points this year and expect credit costs to trend in line with our existing forecasts.

H shares of China Merchants Bank, or CMB, dropped 5.2% in Hong Kong trading April 27 with the market likely disappointed by a 12.6% year-on-year contraction in first-quarter fee income. Wealth management and credit card service income both declined 13% and 6%, respectively, on weak market sentiment and falling credit card consumption from a relatively high base in the year-ago period. We believe the challenges are industrywide rather than company specific. As revenue and net profit performance were within our expectation, and given our view that margins would still be sluggish in first-half 2023, we leave our major assumptions unchanged and retain our fair value estimate for CMB at CNY 55 per A share and HKD 64 per H share. H-shares remain undervalued. We believe current revenue headwinds are largely priced in.

While China Merchants Bank’s, or CMB’s, 2022 revenue and net profit growth of 4% and 15% year on year, respectively, were in line with its preliminary results, its results are nonetheless mixed. On positive notes, net interest margin and cost efficiency improved, and CMB’s return on equity expanded to an industry-leading level of 17.06%. However, in the fourth quarter, CMB’s fee income contracted 1% year on year, lagging the 2.5% and 20% growth of peers China Citic Bank and Ping An Bank, respectively. Overdue loan and special-mentioned loan balances reported larger-than-peer increases from 2021 levels.

The large Chinese banks will release 2022 results in late March and first-quarter 2023 results in late April. Pressures on net interest margin are likely to rise in the first quarter. However, the accelerating recovery in China’s economy since reopening reaffirms our expectation for asset risks to be contained. This allows banks some flexibility in their already-high provision levels, which should enable them to smooth net profit growth despite significant revenue pressures. But we do see a wider divergence in profitability in 2023 as slowing revenue growth results in less leeway to manage earnings growth. Those banks that can benefit from a rebound in retail lending and wealth-management services, which we expect in mid-2023, should present buying opportunities along with stronger earnings performance.

Narrow-moat China Merchants Bank reported better-than-expected annual growth in 2022 net profit of 15.1% to CNY 138,012 million in its preliminary results, beating our projection of 13.6% growth. However, the 4.1% growth in total revenue missed our expectations as the bank was significantly hit by volatility in capital markets. The results reflected a very challenging market environment for Chinese banks in the past quarter on stringent coronavirus restrictions and surging redemptions on bank wealth management products due to poor bond market performance.

China Merchants Bank, or CMB, stands out thanks to its leading position in retail banking business and enviable funding costs advantage, which delivers one of the strongest returns on assets among peers. We believe strong returns and competitive advantages endow it with a narrow economic moat.