Author

研究部 (Research Team)
輝立証券

Phone:	(852)22776555	Email:	research@phillip.com.hk
For Research Report and Business enquiry

China Construction Bank Corporation (939 HK) Profit growth cut, still rated “hold”

Thursday, December 4, 2008

5220

China Construction Bank(939)

Recommendation on 4 December 2008
Recommendation	Hold
Price on Recommendation Date	$4.240
Target Price	$4.660

Weekly Special - 1318 MAO GEPING

Summary

Considering performance for the third quarter dropped QoQ, plus with accelerated interest rate cut, we cut profit forecast for China Construction Bank Corporation (CCB or Company) in 2008 and 2009, with net profit respectively at RMB 103.9 billion and RMB 108.1 billion, growth rate at 50% and 4%. However, after the previous dramatic retreat, in short-term, the market begin to maintain stable, therefore we give 12-month target price at HK$ 4.66, and “hold” rating.

Q3 performance dropped QoQ

CCB`s latest quarterly report for Q3 in 2008 showed, the Company`s achieved turnover for the first three quarters totaled RMB 199.6 billion and RMB 84.3 billion net profit, respectively rose 25.11% and 47.58% year-on-year. Higher growth rates still benefited from expansion of asset and loans size, higher net interest margin and large income tax rate drop. EPS for the first three quarters was RMB 0.361. However, comparing with first half of 2008, major income items` growth rates started to drop:

Net interest income growth dropped to 20.7% from 24.5% of the first half year. Comparing with other major big banks, CCB`s size expansion is more active. While in contrast to the first half, CCB`s NIM slightly dropped by 3BP from midyear to 3.24%. That was caused by rise of time deposit, which was accounted for 47.9% and rose 3 percentage points than midyear. The Company`s comprehensive capital costs added 6 BP from midyear to 2.02%.

Net fee and commission income for the first three quarters was RMB 29.57 billion, basically the same as the previous two quarters, while growth rate declined from 59.3% in the first half year to 29%, because the agency business shrunk, which was caused by funds and insurance sales decline.

Therefore, despite the net profit increase in the first three quarters, the Company`s RMB 25.6 billion single-quarter performance in the third quarter also presented a 4% QoQ decline. The falling rate was not large, smaller than that of Industrial and Commercial Bank of China, but still the unsatisfying one in the whole industry.

Enters interest cut cycle, net interest margin falls

Since the Lehman Crisis occurred in September, People`s Bank of China has cut interest rate for consecutive four times within three months, while the latest move at the end of November exceeded market expectation, with as high as 108 basis points were reduced. We think that along with crisis`s deterioration and the call for economy stimulation, the interest cut will continuously to be implemented and banks` net interest margins will keep sliding.

For CCB, we calculated in line with the newest third quarter and deposit and loan terms structure data, merely the interest cut at the end of November, the Company`s annual net interest margin of 43.5 basis points will be impacted, while the four times interest cuts will affect 89 basis points. Benefited from 57.8% loan and deposit ratio, interest cut this time did not sap performance, but the consecutive four times eroded more than RMB 10 billion, about 7-8% of performance.

However, for net interest income, the Company is still in the face of series of bullish factors, such as relaxation of restrictions on lending, namely the scheduled additional RMB 30-50 billion loan in 2008 for the Company. What`s more, the deposit-reserve ratio continuously decline, and the 1% cut is hopefully to add annual profit by RMB 2 billion. All in all, series of factors is highly expected to retain the affected net interest income within 5%.

Stable assets quality, lower than peer level non-performing loan risk

At the end of 3Q 2008, CCB`s non-performing loan balance was RMB 78.5 billion, added RMB 400 million than midyear, with non-performing ratio at 2.17%, dropped 4BP than midyear. On future market, the banking industry will inevitably be exposed to risk of non-performing loan increase. However, we think that comparing with other rivals, CCB`s risk is lower, and reasons lie in:

Firstly, proportion for high risk industry loan is lower. The proportion for manufacturing and property development industries is around 28%, while for Industrial and Commercial Bank of China, Bank of Communications and CITIC Bank, the ratio is higher than 30%.

Secondly, for the highly risky property development industry, relevant loan proportion dropped in the first half year, the newly-added property development has also avoided 8 cities (whose increment only accounted for 3% of the total) with over speed housing price increase. In contrast to other banks, we will find that CCB`s property development`s new loan and non-performing ratio are both at low level.

Thirdly, comparing with the non-performing ratio in the manufacturing for the first half year, we will know that among the three major listing banks, the rate for CCB is the lowest, only 3.18%, indicating that the risk is still under control.

However, it should be noted that on November 24, CCB issued the housing loan policy, for the qualified commercial individual housing mortgage loan, the loan rate floor was adjusted to 0.7 times of the minimum loan benchmark lending interest rate, and the minimum down payment rate was also adjusted to 20%, while the specific operation would determine by branches and housing loan centers in different places. Comparing with other banks, CCB`s housing loan policy is more loose, and can be both enjoyed by the second housing loan and stock lending, and meanwhile, different branches may have more freedom on practical implementation. Whereas, we are not optimistic on the real estate industry`s development in the coming two years, and current relaxing policy may lead to risk exposure then.

BAC strikes the call option, but possible reduction will suppress stock price performance

CCB announced that the Bank of America Corp. (BAC) has exercised the call option, by RMB 2.46 per share (approximately HK$ 2.8, strike price,1.2 x 2008 BVPS for the first three quarters in 2008) to acquire the 19.58 billion shares held by CCB`s largest state-owned shareholder, Central Huijin Investment Co., and the takeover consideration totaled USD 7.1 billion, which make its holding rise to 19.13%, while Huijin Investment will drop to 57%.Under the moratorium agreement, without CCB`s permission, BAC should not sell these newly purchased 19.58 billion shares before August 29, 2011. On the positive side, BAC`s increase shareholding indicated its willingness of establishing long-term strategic cooperative partnership with CCB.

However, we think the global financial crisis is still not over. BAC may sell the 19.2 billion shares (around 8.2% of CCB`s total shares, with locking-in period ended at October 27) of CCB bought in 2005, which may affect CCB`s stock prices performance.

Risk

Interest cut exceeded expectation. CCB`s performance is likely to be further cut.

Macro-economic gets into downtrend, corporate credit demand shrinkage may continue, which may harm banks` asset quality and credit growth.

Sub-prime mortgage crisis keeps worsening. Global financial system reform is deferred without settlement.

Valuation

All in all, considering the third quarter`s performance declined QoQ and the accelerated interest rate cut, we lowered the income and profit forecasts for CCB in 2008 and 2009. Turnover for 2008 and 2009 is expected to be RMB 259.4 billion and RMB 299.2 billion, with growth rate at 17.5% and 15.3%, the net profit will respectively at RMB 10.39 billion and RMB 10.81 billion, advance by 50% and 4%, and the EPS will be RMB 0.44 and RMB 0.46.

On valuation, along with higher ROE and lower dividend yield, comparing with the global market, H-share banks` lower P/E, but higher P/B, which was boosted by its better assets quality. We think that, along with the economy weakening, the banking assets quality will be affected, and performance growth rate will sharply decline, while after the previous steep retreat, market will be stable in the short time. Current valuation level is appropriate. We give CCB P/E 9 x 2009 EPS, with 12-month target price at HK$ 4.66, nearly 10% higher than current price. We give CCB “hold” rating, while the possible shareholding decrease of BAC may constrain the stock prices performance.

Author

China Construction Bank Corporation (939 HK) Profit growth cut, still rated “hold”

Summary

Q3 performance dropped QoQ

Enters interest cut cycle, net interest margin falls

Stable assets quality, lower than peer level non-performing loan risk

BAC strikes the call option, but possible reduction will suppress stock price performance

Risk

Valuation

Financial data

Contact Us

E-Check

Investor Notes