Last week, we had the opportunity to engage with the management team of the Bank of Chengdu (BOCD) in Chengdu, China. BOCD, founded in December 1996, is a regional joint-stock commercial bank with a diversified equity structure. On January 31, 2018, BOCD debuted on the Shanghai Stock Exchange, becoming the first listed corporate bank in Sichuan Province and the eighth city commercial bank listed on China’s A-share market. BOCD is supported by a network of 256 branches.

The event, facilitated by Hong Leong Bank (HLB) and led by CFO Mr. Malkit Singh, featured key representatives from BOCD, including Mr. Chen Haibo, Vice President and Secretary of the Board, Mr Chong Foo Lim, Risk Advisor as well as Ms. Xie Yanli, Deputy General Manager of the BOD Office. During the session, we also held discussions with senior members from various BOCD divisions, including Financial Markets, Planning and Finance, Risk Management, Personal Financial Services, and Corporate Business.

Overall, we are impressed by BOCD’s 18% ROE, driven by healthy loan growth, resilient asset quality, cost efficiency, and investments in digitalisation and infrastructure. Consensus estimates that BOCD will

Achieve Net Profit Growth of 11-12% Annually for FY24/25/26, Driving

an increasing contribution to HLB’s earnings. We maintain our target price for HLB at RM23.90, which is derived from an implied PBV of approximately 1.33x, based on the Gordon Growth Model and a 3% ESG premium. We reiterate our Buy recommendation on HLB.

Visit to Gain Firsthand Insights Into Chengdu's Economy

The meeting aimed to gain firsthand insights into Chengdu's economy and address prevailing concerns regarding a potential slowdown, both in the city and the broader Chinese macroeconomic landscape. Since BOCD contributes approximately 31% to HLB's overall earnings, any significant economic deceleration in Chengdu could materially affect the group's financial performance. Our analysis indicates that a one percentage point reduction in BOCD's contribution would negatively impact HLB's earnings by an estimated 1.6%.

The tour commenced with a visit to the Chengdu Planning Exhibition Hall, where we were briefed on the city's growth outlook. Chengdu has been designated as a key economic development zone in western China, underpinned by the Chengdu-Chongqing economic zone. The city's strategic plans aim to transform it into a modern socialist international metropolis. In addition to establishing Chengdu as a hub for economic activity and foreign exchange, efforts are also focused on developing the city into a centre for scientific innovation and a national base for advanced manufacturing in Western China.

Chengdu, An Emerging Economic Powerhouse

Chengdu is actively developing industry clusters in electronics, IT, and equipment manufacturing, supported by over 11,500 national high-tech enterprises and a talent pool exceeding 6.2mn. The city is strategically connected to global markets via the China-Europe Railway Express (Chengdu & Chongqing). We view Chengdu as an emerging economic powerhouse, with its 2023 GDP reported at RMB2.23 trillion (USD286bn), positioning it as the 7th largest city in China. Notably, Chengdu's GDP represents approximately 72% of Malaysia's 2023 GDP of USD399.7bn.

During our visit to Chengdu's city centre and financial district, we observed a dynamic, thriving metropolis with high-quality developments, modern skyscrapers, and a blend of traditional and contemporary architecture alongside renowned global luxury brands and international hotel brands. Despite this international presence, we believe large domestic corporations and significant government infrastructure projects will primarily drive Chengdu's future growth. We also had the opportunity to engage with some of BOCD's key clients, such as Tong Wei Co Ltd, a global leader in high-purity polysilicon and solar cell production, and China Construction Group. Notably, we toured a high-end gated residential area developed by China Construction Group, which has reportedly sold out despite broader concerns about China's real estate slowdown.

Corporate Segment Key Driver to Broader Growth

With the corporate segment comprising 70% of BOCD’s loan portfolio, our visits to Tong Wei and China Construction Group highlighted a robust base of high-quality corporate clients. BOCD's customer base also includes many firms listed in the Fortune China 500. While infrastructure project demand has moderated, key sectors such as green hydrogen, electric vehicles (EV), technology, consumer finance, and manufacturing remain resilient and are expected to drive future growth for the bank. As a city commercial bank, BOCD benefits from strong government-linked activities, with local authorities actively facilitating investments to bolster the economy. Approximately 70% of BOCD’s corporate loans are attributed to state-owned enterprises (SOEs), with the remaining 30% sourced from local corporates and SMEs. This strong support and strategic focus have enabled BOCD’s gross loans to grow by 23% YoY in 1HFY24, significantly outpacing the system’s loan growth of 8-9%.

Potential Slowdown in the Retail Segment

Management acknowledged potential headwinds in the retail segment, with consumer spending expected to soften due to subdued sentiment. However, this segment represents only 30% of BOCD's total loan portfolio. On the other hand, the consumer segment has been instrumental in driving deposit growth, as conservative consumer behaviour is leading to increased savings. BOCD's deposits grew by 15% YoY in 1HFY24, reaching RMB839.3bn, positioning the bank as having the third-largest deposit base in Chengdu, trailing only China Construction Bank and ICBC. For comparison, China's total deposit growth was reported at 6.3% as of July 2024.

Solid Foundation for Deposit Growth Strategy

Similar to HLB, BOCD's stable retail deposits make up 50% of its total deposit base, providing a solid foundation for future growth. By deposit type, fixed deposits (FDs) account for 70% of total deposits, while the remaining 30% are current and savings accounts (CASA). Management anticipates continued robust deposit growth, underpinned by BOCD's substantial retail customer base of 11mn, representing nearly 50% of the 21mn population in the Chengdu municipality. This highlights BOCD's financial strength and strong reputation. Additionally, management noted positive net inflows from neighbouring cities and migrants from other provinces. As of June 2024, BOCD's loan-to-deposit ratio (LDR) stands at 84.2%, with a liquidity coverage ratio (LCR) of 286%, well above the industry average of 150-200%.

Resilient Asset Quality

In terms of asset quality, BOCD demonstrates strong performance, mirroring HLB’s resilience. The bank's gross impaired loan (GIL) ratio improved to 0.66% from 0.72% the previous year, supported by a prudent loan loss coverage ratio of 496%, equivalent to 2.5 years of profit. BOCD ranks 1st in GIL ratio and 2nd in coverage among listed city commercial banks. Despite concerns about a slowdown in China’s real estate and residential property markets, management emphasised that Chengdu’s real estate sector remains resilient. While there has been downward pressure on secondhand property prices, new home prices have remained firm. BOCD's conservative risk management practices have resulted in no new non-performing loans (NPLs) from the real estate sector, which accounts for approximately 20% of the bank’s loan portfolio. Additionally, less than 10% of BOCD’s total bond portfolio is tied to local government financing vehicles (LGFV), reflecting the bank's cautious approach to managing credit risk exposure.

Efficient Operations and Digital Transformation Driving Strong ROE

BOCD’s healthy 18% ROE in 1HFY24 is further supported by its ability to maintain a low cost-to-income ratio (CIR) of 23-25%, positioning it among the most efficient banks in its peer group. Management maintains strict cost discipline, with a focus on optimising employee productivity and operational efficiency. However, they remain committed to investing in strategic areas such as IT infrastructure and the modernisation of data centres to future-proof operations. Currently, 98-99% of the bank’s financial transactions are conducted online, underscoring its digital transformation and operational efficiency.

Projected Profit Growth and Rising Contribution to HLB

Consensus estimates project BOCD to achieve net profit growth of 11-12% annually for FY24/25/26, driven by solid loan growth, stable net interest margins (NIM), disciplined cost management, and manageable asset quality risk. We understand that NIM has likely bottomed out and should gradually improve over time. Given BOCD’s robust double-digit profit generation, we estimate its contribution to HLB’s PBT to increase from 31% in FY24 to 41% by FY27. We remain optimistic that BOCD will continue to enhance HLB’s overall valuations.

Valuation and Recommendation

At this stage, we make no changes to our earnings estimates. Accordingly, we maintain our target price for HLB at RM23.90, which is derived from an implied PBV of approximately 1.33x, based on the Gordon Growth Model and a 3% ESG premium. We reiterate our Buy recommendation on HLB.

Source: TA Research - 10 Sept 2024