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China Banks
2009 outlook: Very challenging first half on NIM
squeeze, but still well-positioned to weather macro
headwinds
China
Banks
Samuel ChenAC
(852) 2800-8557
samuel.s.chen@jpmorgan.com
Sunil Garg
(852) 2800-8518
sunil.garg@jpmorgan.com
J.P. Morgan Securities (Asia Pacific) Limited
See page 38 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may
have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their
investment decision.
A and H-share banks’ 12M share price
performance vs. MSCI China
50
60
70
80
90
100
110
120
130
140
Jan-
08
Mar-
08
May -
08
Jul-
08
Sep-
08
Nov -
08
Jan-
09
A Shares H Shares
Source: Datastream, J.P. Morgan research.
• Upgrade SZDB to OW, Lower
ICBC-H to Neutral.
• Cautious in near-term. BOC
would provide near-term
downside protection but
absolute return is only likely
post 1Q09.
• A very challenging 1H09, potential turning point in 2H09. We believe
revenue weakness and investors’s fear of asset quality deterioration may
keep the sector under pressure, particularly in 1H09. A negative growth is
likely in 1H09, given a very high base and peak NIM achieved in 1H08.
However, trend will improve in 2H09 as NIM trend stablizes, in our view.
• Bigger banks with earning resilience may still outperform in weak market.
While we are cautious in near-term and we lowered our 2008 top pick
ICBC-H to Neutral, this is mainly a tactical valuation call. We believe
within H-shares investors shall still focus on bigger banks and actively look
for better entry points, possibly 10-15% below current levels, given their
relatively safe FY09 earnings profile. In our view, these stocks are still
relative safe haven in a likely sharp market correction after recent rally.
• Increase beta as market and economy recovers, likely in 2H09. We see
good chance of global financial market stabilization in 1H09. Domestic
economy may also improve in 2H09. As these happen we believe investors
should switch to BOC, and higher beta stocks that are trading at valuation
discount (such as BoComm). We will not buy CMB-H unless it's 20%
cheaper though. Investors should also buy select A-shares in this case.
• A-share banks may reverse its underperformance after 2Q09. We are
turning more positive on A-share banks given valuation attraction. A-share
may outperform in 2009. Within A-shares we believe valuation discount is
enough to support our preference for selected A-shares including SZDB and
SPDB. While there is less resilience against unexpected drastic asset quality
deterioration, we see less credit cost pressure for these two banks.
• Stock picks: In near-term we would recommend BOC /CMB as a pair trade
idea. At 0.9x FY09E PB, BOC-H may provide more downside protection.
Despite overhang concern, CCB are fundamentally attractive. Within Ashares,
we would prefer SZDB (upgraded to OW) and SPDB. In addition,
BoComm’s A-share trade at a discount to H-shares. For CMB we prefer its
A-share over H-share although we will also buy CMB-A at 10% below.
Investment summary
While we believe that there is no doubt about an expected deteriorating sector
trend, we argue that Chinese banks, especially many bigger H-share banks,
have relative earnings resilience in 2009. A 20-30% earnings contraction would
be a worst-case scenario for bigger banks. That said, we would stay cautious
over the next three months on possible consensus cuts and disappointing
earnings momentum in 4Q08 and 1Q09.
There is no doubt that 2009 would be a very challenging year for Chinese banks.
Having enjoyed a very strong 40% CAGR profit growth in the past three years,
driven by structural profitability improvement led by NIM expansion and strong fees,
Chinese banks might have seen a peak in profitability during 2008 in the current
cycle, in our view. The operating environment deteriorated quite rapidly in the past
couple of months, with interest rates being slashed aggressively by PBOC in 4Q08.
We also believe that the sector will finally come to a point, where an improving trend
in asset quality will reverse, in addition to revenue pressure on banks, mainly from
NIM compression.
We expect the aggregate net profits of the nine banks under our coverage to grow 5%
in 2009, compared with a 55% growth in 2007 and the estimated 37% growth in
2008. This bottom-line growth was still inflated modestly by the Rmb50 billion plus
impairment charges on overseas investment that bigger banks took during 2008—we
don’t see such a scale of impairment in 2009 on overseas assets. On the operating
level, the expected significant NIM compression might lead to a modest low singledigit
contraction in PPOP in 2009.
Investment recommendations
In our view, 1H09 might look particularly challenging, given that many banks
achieved peak NIM and very low credit costs during 1Q08. A higher base would
make Y/Y profit growth look particularly disappointing in 1Q09 and 1H09. We thus
expect banks’ outperformance during 2008 to discontinue in the near-term given the
macro and policy newsflow, potential earnings disappointment from some banks, and
negative Y/Y earnings momentum. In this note, we downgrade our 2008 top pick,
ICBC-H, to Neutral on its relatively high valuations. While we still see a very
resilient earnings profile and its strong fundamentals, we trim the weighting on ICBC
at the current level and look for better entry points.
Within H-shares, we prefer low P/B multiple stocks such as BOC. We stick to our
Overweight call on CCB, although any placement from foreign shareholders may
keep investors nervous. In the near-term, we stick to bigger H-share banks and
believe 1.5-1.6x would be a good entry level to buy ICBC and CCB. This implies
about 10-15% downside from current level.
As the global market stabilizes and the economy shows signs of recovery, likely in
2H09, we will increase beta. We may then increase exposure to BOC and BoComm
too. We also believe that after 2Q09, A-shares have a good chance to reverse their
underperformance in 2008. Valuations of many A-share banks are at a discount to Hshare
peers. For this reason, we upgrade SZDB to Overweight. While we recognize
that bigger state-controlled banks have much more resilience in earnings, within Ashares,
we prefer some smaller banks including SZDB and SPDB. We believe the
valuation discount is enough to justify our preference. These two medium-size banks
also have lower earnings risks from credit charges, due to either excess provisioning
made in earlier years (SPDB) and the focus on low-risk lending in the past two-three
years (SZDB). Investors should accumulate these A-shares on weakness.
In short, 2009 might remain a volatile year, especially in 1H09. This provides some
good trading opportunities, in our view. A defensive strategy might be adopted in
1H09, with focus on bigger names. Investors, however, might gradually increase beta
and switch to stocks with positive catalysts (such as BOC) and higher beta stocks
such as BoComm-H and some other smaller H-share banks, as well as select Ashares,
when there are signs of improvement in the economy, possibly as early as
2H09.
Risks
We believe the major risk to earnings and share performance remains sharper-thanexpected
deterioration in the economy. The pace of deterioration in the real economy
in the past two months in particular, in more capital-intensive sectors, is a key
concern. Despite the Rmb4 trillion fiscal stimulus package and other tax cuts, as well
as the loosening monetary policy, we believe near-term pain is still very likely in
many sectors. As a result, bad news from the macro economy may continue to flow
through, limiting absolute share price performance, at least in 1H09. Patience is still
needed and we would be defensive.
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