FY06 results review

CCB(939) reported net profit of RMB 46,319m in FY06, down 1.7% yoy, and was inline with the market expectation. EPS was RMB 0.206, down 12.7% yoy, mainly due to the dilution effect from IPO. In FY06, effective tax rate went from 14.93% in FY05 back to the normal 29.5% in FY06. Therefore it is worth to point out that the pretax profit growth of 18.7% should reflect the fair business performance of CCB. Some positive takeaways from the results are:

1) Healthy net interest income growth of 20.4% yoy to RMB 140,368m driven by a loan growth of 16.7% and a 1bp expansion in the NIM to 2.79% in FY06. Among which, personal loan growth recorded the fastest loan growth of 31.9% compared to the 16.7% loan growth in corporate loans. We are also pleased to see that the lower yield discounted bills balance actually dropped 17.3%. We think this can actually help to trench the capital fund to more high yield assets and result in a better asset yield return. We expect the expansion trend in NIM should continue for CCB. NIM is expected to reach 2.82% in FY07 based on the hiking rate environment and a better asset-liability mix.

2) Strong Fee and commission income growth. Fee and commission income is expected to be a growing driver for the banks in the next few years. Mainland banks currently had a relatively low percentage contribution of around 10% from Non-Interest Income such as Net Fee and Commission Income and Trading Income, which was far below than the peers average of 30-50% from banks in other developed countries. CCB posted a strong growth of 60.5% in the Net Fee and Commission Income in last yr, significantly increasing its Operating Income contribution to 8.9% from FY05’s 6.6%. We expect Net Fee and Commission Income will grow at 50% yoy in the next few years as a result of the rapid growing areas such as credit card, asset management and insurance business.

3) Improving cost efficiency with cost to income ratio improved to 43.97% in FY06 from 45.13% in FY05. During the period, operating expenses increased 14.8% yoy, well below the 17.8% yoy increase in total operating income.

4) Asset quality keep improving, NPL ratio came down significantly to 3.29% in FY06 from 3.84% in FY05. During the period, Loan impairment charge rose 38.6% yoy to RMB 18,997m. With the rapid rising loan impairment charge, CCB had its NPLs provision coverage raised significantly to 88.24% from 66.78% in FY05. The higher NPL provision coverage should also result in a slower provision charge growth in future which can enhance the profitability of CCB.

Minor impact from the recent rate hike

PBOC announced a 27bps rate hike in the benchmark one year deposit rate and a 18bps rate hike in the benchmark one year loan rate in mid May. The rate hike differs from the expectation of a 27bps rate hike in both loan and deposit rate. As we have pointed out earlier, we hold a different perspective that banks’ NIM will not be significant eroded due to this unparallel rising of deposit cost. We expect there will only be a minor impact on banks’ NIM given that mainland banks generally had a significant portion of their customer deposit (Above 40-50%) in the low yield demand deposit. And the interest rate of this demand deposit actually remained at a low 0.72% p.a. throughout the previous few rate hikes. Therefore the cost of funds of this significant portion remains unchanged despite the hiking rate environment. In our view, we think the current weakness actually offers a good opportunity for investors to accumulate banking stocks. We maintain our bullish call on mainland banks given the strong economic growth outlook and the improving asset quality in China.

Valuation

CCB is now trading at 2.7x 07PB based on our 40% net profit growth assumption in FY07. Our earnings forecast is 10-12% ahead of the street estimates based on our better than expected loan growth and more effective cost control assumption. We set our target price at HK$5.80, representing 3.3x 07PB or 18.8x 07PE. We call for a “BUY” recommendation.