An integrated financial platform with outstanding profitability

China's financial asset management company with the largest assets. China Huarong's total assets reached 1.4 trillion yuan at the end of 2016, maintaining an average annual compound growth rate of 46 per cent since 2012. At the same time of large-scale expansion of assets, the company's profitability remains at the forefront of the industry. After commercial operation, the company has obtained a number of financial licenses and built a wide range of business platforms, including securities, financial leasing, banking, trust, private equity funds and so on. In terms of income composition, China Huarong's core business units include non-performing assets management, financial services, and asset management and investment. The share of revenue of the three major business units in 2016 was 52%, 25% and 22%, respectively.

The operation of non-performing assets with the acquisition and restructuring business as the core: during the rising and prosperous phase of the last economic cycle, Huarong seized the expansion opportunity of the restructuring business and achieved a rapid rise in the total amount of non-performing debt assets of the restructuring category, reaping high interest spreads and deterministic returns, with an annualized rate of return as high as 19.4%. With the impact of the economic downturn and the low interest rate market environment, the yield has dropped to 12.1% of 2016 year by year, but it is still in the leading position in the industry. The non-performing disposal business expanded smoothly: China Huarong began to rapidly increase the scale of non-performing debt acquisitions in the disposal business in 2015, and the proportion of new acquisitions in the disposal business rose rapidly from 14% in 2014 to 26% in 2015. and then to 44% in the first half of 2016, showing a flexible allocation strategy. In terms of the profitability of the disposal business, the net return on disposal continued to decline, from 26.4 per cent in 2012 to 2.9 per cent in 2016. However, the internal rate of return of the disposal business is relatively robust, maintaining at about 16%.

Integrated financial services platform. Centering on the core competitiveness accumulated by the business of non-performing assets, the company relies on the platform of multi-license financial subsidiaries to provide differentiated and competitive comprehensive financial services. It owns Huarong Securities, Huarong Financial Leasing, Huarong Xiangjiang Bank, Huarong International Trust, Huarong Futures, Huarong Rongde, Huarong Real Estate, Huarong International and other platform companies. From the perspective of operating data, Huarong's financial control platform strategy has achieved remarkable results, with eight subsidiaries showing a basically mature operating state, with annual revenue exceeding 2 billion yuan in 2016. At the same time, the three major business units all show good profitability: non-performing assets management, financial services, asset management and investment history, the average annualized return on pre-tax net assets is basically maintained at more than 20%.

The bottleneck of radical expansion strategy. From 2012 to 2016, China Huarong maintained an average annual compound growth rate of 46%, laying the foundation for its strategy of actively expanding and building a financial control platform. But under the supervision of a minimum capital adequacy ratio of 12.5%, the company's rate of expansion is limited by the size of net capital. In the current cycle of large supply of non-performing loans, China Huarong has purchased a large number of non-performing debt assets, the capital adequacy ratio has been low, and the downward space has been very small, which means that the current asset expansion corresponding to net capital has approached the limit. Under this background, China Huarong is actively preparing for A-share listing in order to gain new power for asset expansion.

For the first time, the overweight rating is given, with a target price of HK $3.40. China Huarong has accumulated many years of operation experience and customer base, has excellent government relations and project resources, and has established a profitable comprehensive financial services platform. Non-performing debt assets operation, financial services and asset management and investment three major business sectors coordinated operation, the scale effect is significant. In the next three years, we believe that the company will continue to expand and actively promote the A-share listing plan to replenish the group's capital. At the same time, with the recovery of the economy and the development of the capital market, the acquired non-performing debt assets will gradually cash in income, and the financial services and asset management and investment sectors will also contribute to steady income growth. Judging from the experience of bank asset expansion, we believe that China Huarong's average annual asset growth rate may drop one step in the next three years. Under the assumption that the company's total assets will grow by 15% in 2017-2019, we expect operating income to grow by 21%, 19% and 19% respectively, and net profit to grow by 13%, 18% and 20% respectively. For the first time, we cover the rating of "overweight", with a target price of 3.40 yuan, corresponding to 0.9 times 2017 Pamp B and 6.1 times 2017 Pamp E.

Risk factors: a sharp economic slowdown may lead to a continuous decline in the rate of return on non-performing assets, a substantial deterioration in the quality of corporate assets, and the government's all-round liberalization of non-performing assets management licenses.