China Banking Update：Stronger growth on recapitalization,earnings dilution discounted

China/Hong Kong China Banking Please read the analyst certification and other important disclosures on last page China Banking Update 5 May 2010 Stronger growth on recapitalization, earnings dilution discounted Sector Rating: Overweight (maintained) All China banks under CCBIS’ coverage have reported in-line or outperforming 1Q10 results, except China CITIC Bank (1398 HK). As a whole, they recorded robust intermediary income growth and better-than-expected credit quality in 1Q10, although no positive surprise seen from margin expansion.
Reiterate Overweight for the sector. Earnings dilution from expected recapitalization is already discounted in valuations and China banks will see stronger growth outlook on the back of strengthened capital base. Valued at a FY10F PER of 10.9x and P/B of 1.9x, China banks are priced at discounted valuations given their estimated average ROAE of 19.0% in FY10F, due to expected earnings dilution in light of recapitalization in the coming quarters. In our view, upcoming fund raisings will enhance China banks’ growth potential and strengthen their capital base, offsetting the already priced-in earnings dilution. Moreover, recent market concerns on massive non-performing loans arising from local government financial platforms and policy tightening over the property market have resulted in further correction of the China banking counters and offered better buying opportunities.
Prefer SOE banks to mid-cap banks. We prefer banks with a combination of sustainable high equity return and attractive valuation. Among the six banks covered, we prefer Bank of Communications (3328 HK, Outperform, TP: HK$11.20), Bank of China (3988 HK, Outperform, TP: HK$5.60), Industrial and Commercial Bank of China (1398 HK, Outperform, TP: HK$7.40) and Minsheng (1988 HK, Outperform, TP: HK$9.50). We are cautious on China CITIC Bank (998 HK, Neutral, TP: HK$6.60) and China Merchant Bank (3968 HK, Neutral, TP: HK$21.50). Sector themes in 2Q10
Quantitative tightening by PBOC expected to come to an end. Our macro team expects no further increase in reserve requirements for SOE banks in 2010 following the recent hike of 50bps by the People’s Bank of China, and we believe that room for public operations is also limited due to the pressure of rising yields. With the removal of unfavorable quantitative tightening, we expect China banks to see stable margin expansion for the remainder of 2010.
Recapitalization expected to boost valuations. From late May to the end of 2010, we expect to see a new round of fund-raising moves by China banks. Total amount to be raised in the A- and H-share markets is estimated at RMB509b, or RMB306b for the H-share market alone. We expect earnings upgrades to emerge after recapitalization on stronger growth outlook and strengthened capital bases. Valuation matrix ICBC (1398 HK) BOC (3988 HK) BoCom (3328 HK) CMB (3968 HK) CITIC (998 HK) Minsheng (1988 HK) Price (HK$) 5.7 4.0 8.8 18.6 5.0 8.1 Rating O O O N N O Target price (HK$) 7.4 5.6 11.2 21.5 6.6 9.5 Revision (%) - - - - - - Target P/B (x) 1.7 2.2 2.5 3.2 2.0 1.9 Upside (%) 29.8 40.0 27.3 15.6 32.0 17.3 EPS (RMB) 2011F 0.57 0.47 0.98 1.46 0.54 0.70 2012F 0.65 0.58 1.25 1.77 0.66 0.90 EPS (YoY, %) 2011F 19.3 21.3 25.6 28.2 23.6 9.5 2012F 13.9 23.1 27.2 21.4 20.6 29.8 PER (x) 2011F 8.9 7.6 8.0 11.3 8.1 10.3 2012F 7.8 6.2 6.3 9.3 6.7 7.9 Yield (%) 2011F 4.5 4.0 3.8 2.0 3.7 1.9 2012F 5.1 4.9 4.8 2.4 4.4 2.5 P/B (x) 2011F 1.8 1.4 1.7 2.5 1.3 1.4 2012F 1.5 1.2 1.4 2.2 1.2 1.2 ROAE (%) 2011F 21.6 19.3 23.0 23.4 17.2 14.6 2012F 20.8 20.4 24.7 25.3 18.3 16.7 Closing price on 4 May, 2010 Source: CCBIS estimates Sophie Jiang (8610) 6652 2900 jiangli@ccbintl.com China Banking Update 5 May 2010 2 Table of Contents Stronger growth on recapitalization, earnings dilution discounted ...............................................................................1 Quantitative tightening expected to end .......................................................................................................................3 Recapitalization.............................................................................................................................................................4 Recommendations ........................................................................................................................................................5 Bank of Communications (3328 HK) ............................................................................................................................7 Bank of China (3988 HK) ...........................................................................