Leading Independent Investment Research, Morningstar, Inc.

Morningstar

Leading Independent Investment Research

Morningstar, Inc.

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Equity Bottom-Up

We raise our fair value estimate for <a href="https://www.smartkarma.com/entities/1119" target="_blank" data-smartkarma-citation="entities:1119:1">Industrial and Commercial Bank of China (H) (1398 HK)</a> to CNY 6.5 per share from CNY 5.9 for its A-shares, and to HKD 8.0 from HKD 6.9 for its H-shares. Our increased assumption for net interest margin accounted for HKD 0.6 of the increase, while Chinese yuan appreciation is responsible for HKD 0.4 of the increase; the rest stems from the time value of money. With shares trading at an 8% discount to our DCF valuation, we currently view ICBC as fairly valued.Market sentiment for large Chinese banks has turned more upbeat as industrial profit growth rebounded and financial tightening continues. Banks are the primary beneficiaries of such trends, given their enviable funding strength and strong capital positions. H-share Chinese financials are also seeing rising mainland capital inflow, as they’re trading at discounts to their A-share counterparts. Institutional investors taking advantage of this include insurance companies seeking to reduce earnings volatility by shifting equity investment into listed financial firms with high dividend yields and steady financial performance, in response to the adoption of IFRS 9 in 2018.Contrary to the market, we expect credit costs will remain at their current high level as a result of the adoption of IFRS 9 and further financial deleveraging in the SOE sector in the next three years. We don’t expect the market to further re-rate large Chinese banks higher to the ceiling of the six year historical price/book band at 1.2 times forward price/ book. Our new fair value estimate for ICBC represents 1 time 2018 price/book, assuming 12% growth in book value per share. This valuation remains at the high end of Chinese banks we cover, reflecting our confidence that ICBC’s strong deposit franchise will enable it to avoid the impact of rising funding costs, and provision pressure will gradually ease as earnings growth recovers. We remain convinced of ICBC’s narrow moat, underpinned by its strong retail deposit base and high operating efficiency.Key drivers in 2018 will be net interest margin expansion and steady loan growth; in addition, fee-income growth is likely to recover from 2017’s low base. We estimate NIM will increase 8 basis points and year-on-year growth in interest-earning assets will remain steady at 7.8%, while fee-income growth is likely to pick up to around 5%. This translates to high-single-digit growth in ICBC’s net profits. The interest-rate hike cycle that started in late 2016 has yet to come to an end, as growth in industrial profits (as measured by EBIT) rebounded to a four-year high at 12% by November 2017. ICBC’s quarterly NIM has bottomed out since first-quarter 2017 and increased by 9 basis points by the end of September, more than the 4-basis-point increase for commercial banks on average. Industry-wide NIM expansion was modest when compared with a 46-basis point increase in average loan rates for the industry, indicating intense deposit competition. As the bank with the largest deposit base, ICBC will benefit from rising funding costs and bond yields, offsetting a modest increase in funding costs.Analyst: Iris Tan, CFA

We raise our fair value estimate for Industrial and Commercial Bank of China (H) (1398 HK) to CNY 6.5 per share from CNY 5.9 for its A-shares, and to HKD 8.0 from HKD 6.9 for its H-shares. Our increased assumption for net interest margin accounted for HKD 0.6 of the increase, while Chinese yuan appreciation is responsible for HKD 0.4 of the increase; the rest stems from the time value of money. With shares trading at an 8% discount to our DCF valuation, we currently view ICBC as fairly valued.Market sentiment for large Chinese banks has turned more upbeat as industrial profit growth rebounded and financial tightening continues. Banks are the primary beneficiaries of such trends, given their enviable funding strength and strong capital positions. H-share Chinese financials are also seeing rising mainland capital inflow, as they’re trading at discounts to their A-share counterparts. Institutional investors taking advantage of this include insurance companies seeking to reduce earnings volatility by shifting equity investment into listed financial firms with high dividend yields and steady financial performance, in response to the adoption of IFRS 9 in 2018.Contrary to the market, we expect credit costs will remain at their current high level as a result of the adoption of IFRS 9 and further financial deleveraging in the SOE sector in the next three years. We don’t expect the market to further re-rate large Chinese banks higher to the ceiling of the six year historical price/book band at 1.2 times forward price/ book. Our new fair value estimate for ICBC represents 1 time 2018 price/book, assuming 12% growth in book value per share. This valuation remains at the high end of Chinese banks we cover, reflecting our confidence that ICBC’s strong deposit franchise will enable it to avoid the impact of rising funding costs, and provision pressure will gradually ease as earnings growth recovers. We remain convinced of ICBC’s narrow moat, underpinned by its strong retail deposit base and high operating efficiency.Key drivers in 2018 will be net interest margin expansion and steady loan growth; in addition, fee-income growth is likely to recover from 2017’s low base. We estimate NIM will increase 8 basis points and year-on-year growth in interest-earning assets will remain steady at 7.8%, while fee-income growth is likely to pick up to around 5%. This translates to high-single-digit growth in ICBC’s net profits. The interest-rate hike cycle that started in late 2016 has yet to come to an end, as growth in industrial profits (as measured by EBIT) rebounded to a four-year high at 12% by November 2017. ICBC’s quarterly NIM has bottomed out since first-quarter 2017 and increased by 9 basis points by the end of September, more than the 4-basis-point increase for commercial banks on average. Industry-wide NIM expansion was modest when compared with a 46-basis point increase in average loan rates for the industry, indicating intense deposit competition. As the bank with the largest deposit base, ICBC will benefit from rising funding costs and bond yields, offsetting a modest increase in funding costs.Analyst: Iris Tan, CFA

Increasing FVE for ICBC to Reflect Increased NIM Assumptions and CNY Appreciation

ICBC (H)

Increasing FVE for ICBC to Reflect Increased NIM Assumptions and CNY Appreciation