Mechelany Advisors’ Investment Ideas are here to make our readers make profitable investments over different time-horizons. Our value oriented investment management style and research focuses on cheap companies with great and solid businesses to be held as core holdings in portfolios. We provide individual Investment ideas based on our multi-layered screening and valuation process combining structural, top-down macro, sectoral analysis, bottom-up stock selection and valuation analysis. Our Investment Ideas may be included in our Model Portfolio while some may not be included if they do not fit the global risk profile and asset allocation chosen at the time of selection.
Asset Allocation is all about determining the right strategic entry and exit points into a given asset class or industrial sector to ride bull markets and avoid bear markets.
Turning points are usually marked by a change in investors’ sentiment, itself usually triggered by a change of perception of the underlying business environment.
To be fully effective they need to be confirmed by Technical signals
Today, we have such a change with the Chinese Banking sector, the main beneficiary of the strong economic recovery of China ahead.
The Investment Case
Since 2017, Chinese banks have been in an established bear market that has seen their share prices half over the period.
During that period of time, their revenues have increased by 25 % and their net profits by 14 %, with growth in the latest capped by the drastic Non-performing loan provisioning policies imposed by the PBOC – 150 % of NPLs on average – flat yield curves and, in 2020, the impact of COVID -19 on businesses and defaults.
2020 should have been a bad year for Chinese banks, but most of them wrapped a volatile year with their fastest rebound in quarterly earnings in at least a decade as a revival in economic growth propelled lending and eased pressure on borrowers.
Agricultural Bank of China Ltd. and Bank of China Ltd. today reported earnings growing by 61% and almost 70% in the fourth quarter, respectively. Bigger rivals Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp. last week posted gains of 44% and 56%.
China’s closely managed $50 trillion banking industry is recovering as the government lets up on requirements to help millions of struggling consumers and businesses with the virus outbreak largely under control.
Expectations that big banks face easing political pressure to support pandemic-hit firms, coupled with the prospect of rising interest rates, are seen bolstering earnings for banks.
China’s central bank last week asked lenders to keep loan growth stable and reasonable as the “foundation of the real economy’s recovery is not yet solid, and the structure of credit in important areas still needs to be enhanced.”
Overall, in 2020, under the guidance of the PBOC, Chinese banks have been forced to write off considerable amounts of bad debt and their ratio of Non-performing loans has increased by 25 %, taking a significant toll on their earnings. The strong result published by most of the banks mean that despite these prudent policies, banks have performed relatively well in the exceptional situation of 2020.
Looking into 2021, strong economic growth in China – OECD forecast of +8.2 % for the year – should bode well for the sector which is essentially a global call on economic activity.
From a pure macro-economic and cyclical standpoint, the timing seems be the sweet spot to build exposure to the sector:
. Strong economic growth means more demand for credits
. Strong economic growth means less defaults and Non-performing loans
. Strong economic growth also means a sharply positively sloped yield curve in China, a key driver of banks profits.
The sharp rebound in US bank shares in the past few months testifies of the link between economic recovery and bank stock performances
From a valuation standpoint, the sharp bear market experienced since 2017 has left Chinese banks trading at their lowest valuation metrics in more than a decade, with prospective P/E ratios below 5x ( 10x in the US ) , Price to Book ratios at 0.38x ( 0.9x in the US ) and dividend yields above 7 % ( 2.8 % in the US ).
The Chinese banks are the largest in the world, they service the largest and fastest growing economy in the world, and are by far the cheapest in the universe of world’s banking stocks.
A Major Technical Breakout and LT BUY Signal
Finally and as always, our timing for the recommendation really comes from a major and general break-out from their downtrend, a sure sign that a new bull phase is about to start.
Those breakouts are extremely significant in terms of timing of asset allocation, especially if they come all at once in a given sector. They reflect a change of sentiment with investors which is also in tune with a change in the fundamental major-economic and micro-economic conditions of the sector.
We recommend investors to allocate funds to the sector strategically, using a basket of the 6 largest and most attractive Chinese banks.
Our recommended portfolio is detailed below with both the fundamentals and the technicals for each bank.
BUY Bank of China 3988 HK
@ HKD 2.95
Bank of China is China’s 4th largest bank and the world’s fourth largest bank by assets, employing 300’000 employees serving 400 million corporate and individual clients, It is also the most international Chinese Bank with a large presence abroad, something that should have capped its results in 2020. Nevertheless, the latest figures reported for 4Q show net income up 70% to 45.2b yuan and a NPL ratio up to 1.46% vs 1.37%
Bank of China revenues should still be growing marginally in 2020 when compared to 2019 and are expected to reach an all-time high in 2021 at 610 Billion CNY. Net profits rose to a record high in 2020 and are expected to rise another 8 %. in 2021.
Bank of China’s offshore loan quality and low provision coverage may heighten investor concern, despite 2020’s big profit beat on much smaller loan charges in 4Q. Earnings before preferred dividends reached a record 193 billion yuan in 2020 vs. 173 billion consensus, due to 4Q’s 69% jump.
Problem loans in offshore markets rose 109% last year, while the nonperforming-loan (NPL) ratio surged to 0.64% from 0.3% in 2019. Markets other than Hong Kong and Macau, the main source of new bad debt, may face lingering risk. BOC’s NPLs rose 16.3% in 2020, even after writing off and transferring out 64.3 billion yuan of stage 3 assets. A brighter outlook of BOC’s lending and fee income may partly offset the above negatives. Steadying margin and limited cost growth are bright spots.
BOC may also be affected by China’s new regulatory ceilings on property and home loans. The expense base could remain rigid on salaries, fintech investments and depreciation.
Bank of China trades at 4.6 x earnings, and a low 0.37 % Price to Book value. Its divided yield at 7.2 % is the highest in a decade and its dividend is expected to remain stable at 0.167 CNY per share.
As can be seen from the chart below , both PE ratios and P/B ratios are at the lowest seen in a decade, providing an excellent entry point if, as we expect, anew phase of valuation expansion is about to take place as sentiment for the sector changes.
Moreover, Bank of China H-Shares trade at a 33 % discount to their Domestic A-shares equivalent
Analysts have started to raise their ratings and target prices on the stock with an average 12 months target price of HKD 3.47, a 17 % increase frm current price.
Bank of China H-shares have now broken put of their long term downtrends in a significant breakout. They are now trading above their ST moving average and testing their MT Moving average.
And are now breaking out of their well-established long term downtrend channel after a significant long term double bottom at 2.5.
The last chart shows A MAJOR LONG TERM BUY SIGNAL on the MACDs that cannot be ignored.
BUY Ind. and Com. Bank of China 1398 HK
@ HKD 5.59
Industrial and Commercial Bank of China ICBC is the world’s largest bank. ICBC employs 435 million people serving 650 million individual clients and 8 million corporate clients mainly in China. The bank has in excess of US$ 5 trillion in assets, generates US$ 146 Billion in revenues annually and US$ 52 billion in profits.
ICBC reported its full 2020 results on March 26th and its revenues have grown 6.7 % in that year despite the impact of COVID-19 and are expected to grow another 8.7 % in 2021.
Net profits reached an all-time high in 2020 and will will grow another 6.7 % in 2021. 4Q net income was up 44% to 87.23b yuan and NPL ratio to 1.58% as of Dec. 31 vs 1.43% a year earlier.
Industrial & Commercial Bank of China’s (ICBC), the world’s largest bank, could set the tone for the Chinese banking sector’s earnings recovery this year. The lender focuses on keeping its loan book clean by disposing of problematic assets. Credit costs should moderate this year after large charges taken in 2020. Margin pressure is easing on tightened market liquidity and rising loan pricing led by property lending red lines. ICBC’s business should be the main beneficiary from the expected economic recovery in China.
ICBC is trading on an un-demanding 5.5 x P/E, 0.63 Price to book ratio and pays a dividend yield of 5.65 %. Its earnings yield is 18 % based on 2021 net profits expectations.
As the following graph shows, ICBC trades at the very low end of its valuation in the past 10 years on both P/E and Price to Book
Analysts have started upgrading the stock with NO Sell ratings and only 2 Hold ratings left.
Target price is at 6.54, a 17 % upside from current levels.
ICBC has now clearly broken the downtrend in place since 2018, climbed above its ST and MT moving averages and is now testing its LT moving average
The Monthly chart shows a clear break out of the downtrend channel, with a target at 7.10
and the MACDs are delivering a significant LT BUY Signal
BUY Agricultural Bank of China 1288 HK
@ HKD 3.11
Agricultural Bank of China ( ABC or AgBank) is China’s third largets bank by asset and China’s and the world’s largest bank by number of clients with 837 million individual customers and 6million corporate customers, services through a network of 23’000 branches.
The group employs 455’000 people and has US$3.81 trillion of assets.
AgBank just reported results for the full year 2020 that beat the average analyst estimate.
Net income was 215.9 billion yuan, +1.8% y/y, against estimates of 198.17 billion yuan.
Net interest income was 545.1 billion yuan, +8.8% y/y, against estimates of 531.65 billion yuan
Non-performing loans ratio rose to 1.57% vs. 1.40% y/y. Coverage ratio for non-performing loans 260.6% vs. 288.8% y/y.
Final dividend per share was set at 18.51 RMB cents vs. 18.19 RMB cents the year before and estimates 17.30 RMB cents leaving the stock with a high 7.05 % dividend yield.
Agricultural Bank of China’s earnings may hinge on its ability to contain risks to loan quality in 2021, and jettisoning assets may be one of the options on the table. Provision coverage still stood at 253% after its 1Q-3Q20 credit costs rose 33.5%. Margins may stabilize on a possible rebound this year for loan pricing and asset yields. Fee growth could stay modest once China’s economy recovers from the pandemic. AgBank’s profit should grow 6.8% in 2021, based on consensus to reach a new all-time high.
Bank is dead cheap. With a P/E ratio of 4.4x, a Price to book ratio of 0.50 a dividend yield of 7 % and an earnings yield of 18.55 % based on the just reported net profits for 2020.
Never in its history have its valuation metrics been so low….
As for all the other banks, analysts have been upgrading the stock and there are now NO sell ratings and only 2 Hold ratings remaining. The consensus target price is 3.80, a 22 % increase for current levels.
AgBank has definitely broken its downtrend in place since 2018 and is now trading above its ST and MT moving averages after lengthy 6 month consolidation
The weekly chart confirms that it has broken out of its downtrend channel after having rebounded on a massive long term, decade long support at 2.50.
and a clear long term BUY signal confirms the change of secular trend. ( Bottom panel of the chart below.
BUY China Construction Bank 939 HK
@ HKD 6.60
China Construction Bank is China’s and the world’s second largest bank by assets and by tier-1 capital. It originally specialised in financing infrastructure and real estate but has now evolved in a global commercial bank providing a comprehensive range of commercial banking products and services. It is China’s largest mortgage lending provider, both a blessing because of China’s strong real estate market and a curse because of the Government’s policies to curb speculation and mortgage lending in the future
The company employs 350’000 employees and serves hundreds of millions of retail and corporate customers.
China Construction Bank reported strong results for 2020 without revenues climbing to an all-time high of CNY 764 Bln. CCB’s profit reached 271.1 billion yuan in 2020, beating consensus’ 253.2 billion yuan, mostly due to 4Q’s 57.6% bounce on smaller credit costs.
Its profit growth could be slowed by regulators’ property-loan ceilings and lingering asset risks in 2021, as the bank is the nation’s largest mortgage lender. CCB may need to contain mortgage growth due to the 32.5% cap on housing loans. The curb could weaken its pretax profits by 1.9% a year in 2021 and 2022. CCB’s problem loans rose 22.7% last year, even after it wrote off and transferred out 103 billion yuan of stage 3 assets. Its NPL ratio climbed to 1.56% from 1.42%. Provision coverage fell, though it remains above 200%. Steadying margins and fee growth could be the bright spots.
CCB trades on 5.2x earnings, a 0.62 % price to book value and serves a dividend yield of 5.8 %. It boasts an extremely high earnings yield of 19.1 %
As is the case with all the Chinese banks, valuation metrics are at the lowest in a decade and have considerable upside potential as a valuation re-ratoing is on the cards
Analysts have been upgrading the stock and are now uniformly bullish on CCB with a price target at 8.44, a 27 % increase form current levels
CCB has clearly broken out of its down channels is now trading well above its ST and MT Moving averages and is testing its LT moving average
The long term chart shows a clear change of trend, a massive LT BUY signal on the MACDs and a target price of HKD 8 as the next major resistance.
BUY China Minsheng Bank 1988 HK
@ HKD 4.53
China Minsheng Banking Corporation Limited is China’s first national commercial bank founded and privately owned by non-state-owned enterprises. Total assets of the China Minsheng Bank group amounted to US$ 1 Trillion, revenues for 2021 are expected to reach US$ 32 Billion and profits 7.8 Billion.
The Bank operates branches in 41 cities across China, with 2,427 banking outlets. It employs 55’000 people.
According to The Banker, in 2020, China Minsheng Bank was ranked 23 largest bank in the world and stood at No. 239 in the Fortune global 500 companies.
Today, Minsheng Bank reported net income for the full year that missed the average analyst estimate. Minsheng’s profit plummeted 36.3% in 2020, missing consensus, due to a 2.2 billion-yuan 4Q net loss. Contrary to State banks, the largest of China’s Private Banks chose to provision all the bad things of 2020 in the fourth quarter of 2020.
Net income was 34.3 billion yuan, -36% y/y, estimate 46.35 billion yuan
Net interest income 135.2 billion yuan, +11% y/y
Non-performing loans ratio 1.82%
Net fee and commission income 27.7 billion yuan, -1.8% y/y
EPS 71 RMB cents vs. 1.22 yuan y/y
Final dividend per share 21.3 RMB cents
Net interest margin 2.14%
China Minsheng Banking’s 2020 profit plunge signals outsized 2020 loan and provision risks. Bad loans rose 28.7% last year even after write-offs and disposals. The nonperforming-loan ratio climbed to 1.82% from 1.56%. Provision coverage fell to 139.4% in 4Q — the lowest among major Chinese banks — from the already-low 145.9% in 3Q, even as impairment charges increased 54.6% year-over-year in 4Q.
Revenue may grow mid- to high-single digits in 2021, thanks to steady margin and double-digit loan growth. Trading income could be a big top-line variable, while fee growth may pick up on bank card and settlement businesses.
The bank announced a cut in its dividend to RMB .23 for 2020 and guidance is for .34 in 2021.
Contrary to the large state-owned banks, privately-owned Minsheng Bank seems to have taken the decision to front-load costs and bad debt charges in 2020, hence the sharply negative surprise in Q4 2020 results. Like all the other banks, Minsheng is highly geared to China’s economy and should have seen a strong recovery in business, revenues and margin in Q4 2020 as testified by its full year 11% growth in net interest income.
The 2020 one-off charges mean that the 2021 recovery will be actually stronger than with the other large banks.
The fall in the stock price after the 2020 results provide a great entry point at extremely low valuations with a P/E of 3.3x and a Price to Book of 0.32x. Its cut dividend 2020 still delivers 5.6 % yield and should increase to 11.94 % in 2021. Its earnings yield is at 16.6 %
The stock is trading at the lowest valuation metrics ever
Minsheng is not yet out of its bear market. However, as the middle chart shows, a very significant bottom has been made at HKD 4.0 and this support should hold. So any weakness in the stock is an opportunity got add to positions.
The last monthly chart shows that a secular BUY signal is forming on the MACDs
BUY China Communication Bank 3288 HK
@ HKD 4.95
Bank of Communications Limited, founded in 1908, is the fifth-largest bank in China and the 24th largest bank in the world.
Established in 1908 and headquartered in Shanghai, Bank of Communications is one of the oldest financial institutions a in China and is one of the few banks to have issued banknotes in modern Chinese history.
Bank of Communications runs 3,529 outlets in 239 large-and medium-sized cities. It has 21 foreign branches including banks or representative offices in Hong Kong, New York, Singapore, Seoul, Tokyo, Frankfurt, Macau, Ho Chi Minh City, San Francisco, Sydney, United Kingdom, Toronto, Luxembourg, Brisbane, Taipei, Paris, Rome, and Brazil.
Bank of Communications’ business covers commercial banking, securities, trust, financial leasing, fund management, insurance, and offshore financial services.
It employs 86’000 people and is expected to generate a record US$ 39.3 Billion revenues in 2021
Bank of Communications (3328) reported its 2020 and Q4 2020 results on March 26th with net profit up by 1.3 percent to 78.27 billion yuan year-on-year in 2020. Both revenues and net profits marked a new all-time high.
Net interest income increased by 6.4 percent to 153.37 billion yuan, while net operating income grew by 6 percent to 246.72 billion yuan. Net fee and commission income also grew by 6.4 percent to 45.09 billion yuan.
It declared a final dividend of 0.317 fen per share for 2020, higher than the 2019 dividend giving it a high dividend yield.
All this numbers should be put in the context of a difficult Q1 and Q2 in 2020.
Bank of Communications’ profitability remains in the shadow of loan risks and, to a lesser extent, lower-than-peers revenue growth. Provisioning may improve at a slower pace than other banks this year due to its much lower problem loan allowance of 143.9%. Its bad loans rose faster than peers, too. Asset growth could hinge on its deposit-taking ability, which was weak in 2019 but slightly improved last year. Steadying margins could be offset by weaker-than-peers loan growth, keeping revenue in check. Consensus estimate of a 9.5% return on equity in 2021 is the lowest among China’s six big state banks.
BOCOM is cheap at 4.2x earnings, 0.42 Price to Book and a stable 7.6 % dividend yield. Earning yield stands at 23 % when using 2020 Net profits,
BOCOM’s valuation is at the lowest ever historically and the metrics have started to turn.
Analysts are upgrading the stock and range their price target to 5.6 / 5.8 since the publication of the results, a 15 % increase from here.
BOCOM has clearly broken its downtrend channel and its moving averages are turning up.
A strong BUY Long term BUY signal has been conformed at the MACDs and a break of the 5.6 level will mark a major breakout from the long term triangle that started in 2007.
China is today the world’s second largest economy and it is by far the fastest growing economy powered by a massive consumer market.
It is expected to surpass the US economy in 2028 and should continue to grow at a 5 % rate over the coming five years.
Its banking system is the largest in the world and is THE MAIN BENEFICIARY of the coming surge of economic activity.
The time has come to make a strategic allocation to China’s banking system and benefit from its extreme levels of undervaluation, both historically and in absolute terms with close to 7 % dividend yields, 4.5 x Price earnings and a Price to book ratio at 0.50 %, a deep discount form its US counterparts.
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