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BOC(3988) : Solid 1H06 result, remains positive on full year results

Tuesday, September 5, 2006

5351

BOC(3988)

Recommendation on 5 September 2006
Recommendation	Buy
Price on Recommendation Date	$3.380
Suggested purchase price	$3.370
Target Price	$3.840

Weekly Special - 603179.CH Xinquan

Company overview

Bank of China group (BOC) is the second largest commercial bank in China in terms of assets size (including both domestic and overseas operations or the forth largest excluding overseas operations). BOC was established in 1912 and served as a foreign exchange bank until 1949. After the economic reform in the late 1970s, BOC has become an independent bank specializing in foreign exchange activities. In 1994, the implementation of the Three Policy Banks by the China Government to serve the policy lending functions had helped to transform BOC and other banks including ABC, ICBC and CCB in becoming the Big Four state-owned commercial banks.

Solid 1H06 results, remains positive on full year result

On 30th Aug, BOC has revealed its first interim result since its IPOs earlier this year. The set of results showed impressive improvement in all aspects with a reported net profit of RMB 19,477m in 1H06, an impressive 28.3% yoy growth and beating market estimates by 14%. With the IPOs dilution effect, EPS was up 9.7% resulting to RMB 0.089. BOC has achieved 59% of the FY06 target of RMB 33,000 as stated in the prospectus.

BOC recorded a solid 13.3% yoy growth in total operating income, mainly driven by the 51.4% yoy growth of net fee & commission income. Among which, settlement and clearing fee, agency commission and bank card fees were all showing robust double digits growth. Although net fee & commission income contributes only around 9.84% of the total operating income currently, it is expected this portion would encounter significant growth in the next few years as more financial products and banking consultancy services are introduced to customers.

Net interest income, accounting for 78.9% of the total operating income, has posted a 12.3% yoy growth with an underlying loan growth of 7.7%. Since loan growth is relatively slower compared to CCB’s and BoCom’s growth rate of around 15% (reaching the target set by PBOC), BOC should continue to record reasonable loan growth in 2H. We expect a full year loan growth of 12.5% for BOC in FY06 as compared to the other two banks which should see a flat loan growth in 2H06 under the macro tightening policy. As such, BOC’s 2H06 performance should be more favorable among the three banks.

Negative: FX loss arising from RMB appreciation

BOC encountered an FX loss of RMB 3,500m in 1H06 and dragged the net trading income down by 80.1% yoy resulting in a half year contribution of RMB 557m only. BOC has a net FX position of USD 39bn as of the last year. In June this year, BOC converted only USD 3.3bn out of the net USD 11.2bn IPO proceeds into RMB, exacerbating the net FX position exposure to a total of USD 47bn as of June 06. During the analysts meeting with management, it is revealed that management will reduce FX holding by USD 14bn as to comply with the target of converting USD 15-20bn set out during the IPOs. FX loss in 2H06 should be reduced and under control despite the ongoing RMB appreciation pressure.

NIM should reach the trough

BOC reported a NIM of 2.27% in 1H06, down 4bps yoy or 8bps hoh. Annualized asset yield reached 4.14% in 1H06, up 47bps yoy or 7bps hoh, driven by both a higher yield in Loans and advances to customers and investment securities. Annualized funding cost on the other hand reached 2.02% in 1H06, up 55bps yoy or 18bps hoh, mainly driven by the higher customers deposit cost. With the funding cost rising faster than the asset yield, net interest spread was contracted to 2.12%. Despite the narrowing trend in NIM and net interest spread, management is confident to have its FY06’s NIM to remain at FY05’s 2.33% given that:

1. The rate hike in April (27bps hike in 1yr benchmark lending rate) and August (27bps hike in both 1yr benchmark lending/deposit rate) should drive a higher asset yield with the full impact be observed in 2H06

2.A steeper yield curve resulted from the previous rate hike should help to improve the NIM

In our view, we expect that NIM has reached the trough in 1H06. We factor in a NIM estimate of 2.29% in FY06 (or NIM estimate of 2.45% in 2H06) for our earnings forecast.

Assets quality continues to improve

Assets quality continues to improve with falling NPL ratio and special mention loan ratio. NPL (including substandard, doubtful, loss) went down from 4.62% in FY05 to 4.19% in 1H06.

Valuation

With positive earnings driver likes further loan growth room, recovery of NIM and an expected reduction in FX loss in 1H06, we remain our positive call on this counter. Our target price of HKD 3.84 is based on a 2.35x forecast 07 PB multiple.

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