Abstract: after two consecutive years of decline in performance in 2015 and 2016, Hanhua Financial's net profit increased by 8.7% in 2017, mainly due to economic stabilization and the company's restructuring of its business to strengthen risk control. Return on equity bottomed out, rebounding to 4 per cent from 3.8 per cent in 2016. At present, the net ratio of the stock market is only 0.36 times, and we believe that the current valuation fully reflects the low return on equity. If the return on equity continues to improve, we believe that the opportunity for share prices to rise will be higher.
In addition, the dividend yield of major Chinese banks has fallen to 5 per cent, 5.5 per cent, after a recent market revaluation, while the dividend yield of Hanhua Capital Holdings is more than 7 per cent, which is relatively attractive.
As asset quality improved, profits bottomed out. Hanhua Financial made a net profit of 263 million yuan in 2017, an increase of 8.7% over the same period last year. This is the first profit growth since 2014. As the economy stabilized, the allocation ratio for several major businesses fell in 2017 compared with the same period last year, while the asset quality of major Chinese banks showed a similar improvement. In addition, since 2015, the company has reduced its exposure to high-risk industries (real estate, metal smelting, etc.), and while this adjustment process has led to a decline in revenues in 2015 and 2016, it has helped to stabilize overall asset quality.
Partner financial business is expected to improve in 2018. Net fee and interest income from partner financial services (mainly credit guarantee and capital operations) fell 13.6 per cent to 1 billion yuan in 2017 compared with the same period last year. However, we believe that this year's performance is expected to improve. The company's total guarantee liability balance in 2017 was 46.5 billion yuan, an increase of 51.7% over the same period last year. Since the company's balance growth in 2017 was mainly concentrated in the second half of the year, last year's earnings did not fully reflect its recovery. It is particularly encouraging that the debt balance of its traditional financing guarantee business is mainly driven by customers with guarantee balances of less than Rmb3 million (up 75 per cent from a year earlier). As customers become more diversified, risks should be more manageable.
SME loan business recovers strongly. The pre-tax profit of the SME loan business rose 117 per cent year-on-year to 259 million yuan in 2017, mainly driven by a 23.7 per cent increase in income and a 26.1 per cent reduction in impairment losses. One of the main drivers of growth is the "Fanjie loan" business, whose loan balance rose 23.7 times year-on-year to 2.56 billion yuan. Due to the full value of real estate as collateral, the risk is relatively low, so the company is willing to actively develop the business. Although average interest rates and process rates fell from 14.7 per cent in 2016 to 13.6 per cent in 2017, the business as a whole still brought significant benefits because of its higher growth and lower risk, as shown in the 2017 results.
Other business units will bring synergy in the future. Although the company has undergone a painful adjustment process over the past two or three years, it continues to build an integrated financial group with a view to creating synergies in the future. For example, Chongqing Fumin Bank, the first private bank in the Midwest, started operations in 2017 and contributed 10.8 million yuan in net profit to Hanhua Financial Holdings. Fu an Financial Asset Management (55 per cent owned by Hanhua) will also help the company improve its overall risk control because it is a local asset management company in Liaoning that focuses on dealing with non-performing assets.
Low price-to-book ratio and high dividend yield are expected to support the share price. Hanhua currently trades at a price-to-book ratio of 0.36, a valuation that fully reflects the low return on equity of 4%. As the economy stabilizes and asset quality improves, share prices should have a better chance of rising if the return on equity continues to improve. Since the leverage ratio (asset / equity) was only 2.7 times at the end of 2017, there is still plenty of room for companies to increase leverage to improve return on equity. In the past, when the company's dividend yield exceeded 7 per cent, it had little valuation advantage over the major Chinese banks, but the dividend yield fell to 5 per cent 5.5 per cent after the main Chinese banks were revalued by the market last year. Therefore, we believe that Hanhua Financial Holdings should be attractive to investors with a longer investment period.
