We attended an International Investor Day event hosted by Bank of Chengdu (BOCD), HLBANK’s 19.8%-owned associate. The event provided stronger insights on the operations of BOCD, the bank’s interplay with the state and economic developments within Chengdu. Their reaffirmed strong fundamentals prompted us to return from the event encouraged that its high ROEs will be supported, but we maintain our forecast contributions from BOCD for now as HLBANK is likely to face dilution risks to its stake in the former. Maintain OUTPERFORM call and GGM-derived PBV TP of RM27.40. HLBANK is one of our Top Picks for the sector.

An applauded investment. HLBANK first became a strategic foreign investor in 2008 by acquiring a 19.99% stake (now 19.8%) in BOCD for RM946.5m. In FY24, BOCD’s associate contributions of RM1.59b made up 31% of group earnings and led ROE to 11.8% (stripping this out would translate to 9.9%). Based on 6 Sep 2024 share price, BOCD’s market cap of RMB51.4b translates to an effective equity value equating to c.RM6b to HLBANK.

Top class books. Based on BOCD’s 1HFY24 earnings report, BOCD’s asset size of RMB1.2t seems small in comparison to the top five banks in China averaging c.RMB35t. That said, BOCD is fundamentally superior against the industry with a CIR of 24% (vs industry’s average of c.39%), loans growth at +23% (vs c.10%), and ROE of 18% (vs c.11%). It is highly safeguarded by a NPL coverage ratio of c.500% in spite of a GIL of c.0.7% (vs c.1.4%).

We reckon these are thanks to its high concentration of state-owned enterprises making up c.49% of its total financing books. BOCD’s exposure in the seemingly troubled real estate market is fairly benign with property developers and contractors comprising of 5% and 4% of total financing, respectively. Meanwhile, its mortgage books only make up 13% and are almost entirely contained within Chengdu itself.

(refer to the overleaf for commentary and observations on Chengdu).

A chance for further traction. BOCD’s associate contribution of RM1.59b to HLBANK was a result of a 5-year net profit CAGR of 23%. While its past loan growth CAGR has been 27%, and is driven by state projects, we derive more comfort that near-term visibility from revenue stems from an uplift in its NIMs of 1.66% (-15 bps), which is below the industry’s trailing average of 1.80%. Recovery may soon be due with the expiry of fixed deposits (c.65% of total deposits) which presently accrue higher interests. Meanwhile, the group recently completely its in-house data centre and is in the midst of relocating its new headquarters by 4QCY25. The normalisation of establishment costs beyond this may lower its already modest CIR back to c.21%, its recent low.

Forecasts. Unchanged. While we note the abovementioned earnings catalysts above, we are wary of possible stake dilution for HLBANK to 17.8% (from 19.8%) owing to the issuance and likely exercise of BOCD’s convertible bonds by other minority holders. Recall that in Mar 2022, HLBANK had similarly exercised its portion of the convertible bonds to raise its effective stake to 19.8% from 18.0%. Granted, we do not believe HLBANK may consider disposing its stake completely in the near term as an ROE of 18% may be difficult to replicate with other investments.

Maintain OUTPERFORM and TP of RM27.40, based on an unchanged GGM- derived PBV of 1.35x (COE: 9.9%, TG: 2.5%, ROE: 12.0%) We continue to view the stock as a solid pick for investors seeking stability, as the group’s GIL ratio remains to be one of the lowest amongst peers whilst it is still able to generate better-than-industry loans growth. BOCD is expected to be a sustainable contributor in the near term (still more than 25% of pre-tax profits). That said, dividend expectations are moderate against the group’s emphasis on sustainable payments. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us.

Risks to our call include: (i) higher-than-expected margin squeeze, (ii) lower-than-expected loans growth, (iii) worse-than-expected deterioration in asset quality, (iv) further slowdown in capital market activities, (v) adverse currency fluctuations, and (vi) changes to OPR.

Source: Kenanga Research - 10 Sep 2024