Bank of Communications has been the benchmark for bank stock market in the past three years. It profoundly reflects changes in valuation. Bank of Communications has accumulated a cumulative increase of 75% from 2021 to the end of 2024Q1, leading the sector. Major state-owned banks have been rising for six consecutive quarters. Economic expectations have not improved significantly during this period, and industry sentiment is under pressure. We believe that the core logic of countercyclical markets is not a “short-term defense,” but rather a comprehensive repair of unreasonable undervaluation over a long period of time. As the leading bank with the most reliable sustainability and the strongest principal credit, the ultra-undervaluation of major state-owned banks overresponds to operating pressure, but clearly underestimates fundamental resilience. Currently, the ROE decline has not bottomed out, but PB valuations have already rebounded first. If ROE is confirmed to bottom in the future following the economic cycle, the recovery in valuation may be even more drastic.
As economic transformation decelerated, the real estate cycle declined, and risk-free interest rates declined, the market began to focus on allocating high-dividend assets. The valuation system for bank stocks has also undergone profound changes, weakening the procyclical nature and strengthening the dividend attribute. Under the new valuation system, large banks have become the center of pricing. Reasonable dividend rates should anchor risk-free interest rates and match stable dividend assets in some high-quality industries (such as utilities, etc.). As of 2024/04/08, Bank of Communications's dividend ratio surpassed the treasury bond yield of 344BP, which is very attractive.
The improvement in asset quality is the most profound change in fundamentals. After a successful three-year offensive, Bank of Communications is the only major bank rooted in the Yangtze River Delta. It has the advantage of “Shanghai as home”. Under the direction of future domestic “big provinces taking the lead” in regional economic development, investment and financing needs and asset quality are more stable. Since the launch of the three-year asset quality campaign at the end of 2019, the non-performing rate has dropped from a high point of 35 BP to 1.33% at the end of 2023, reaching the average of the four major banks. The net generation rate of non-performing goods has also improved markedly. The provision coverage rate has clearly rebounded for three consecutive years, and the core asset quality index has reached the best level in recent years.
In the public loan sector, the manufacturing non-performing rate continues to decline. At the end of 2023, real estate loans accounted for 6.1%, higher than the four major banks. The non-performing rate was 4.99%, up from the end of June, but the absolute level was lower than the four major banks. Considering that the business is focused on developed regions such as the Yangtze River Delta, the project risk and final loss rate are expected to be relatively manageable. In the retail loan sector, the credit card defect rate for personal loans has always been higher than that of the four major banks, but it has continued to improve in recent years. At the end of 2023, the bad credit card rate fell to a new low of 1.92% in recent years.
Interest spreads are expected to bottom out first, asset pricing is fully adjusted, and there is considerable room for debt improvement. The loan growth rate in the past two years was lower than that of the four major banks. The loan growth rate in 2023 was 9.1%, but we believe that stable scale growth is more beneficial for stabilizing net interest spreads, saving capital, and managing risk. Loan yields have historically been higher than those of peers, but have now been fully adjusted. Retail loan yields fell 106 BP from 2020 to 2023. The decline was significantly more than that of the four major banks, and the yield level has settled sharply.
There is a clear gap between the debt structure and the four major banks. At the end of 2023, deposits accounted for only 66%, and the share of interbank debt and bonds was much higher than that of the four major banks. The high debt cost ratio was a core factor driving down net interest spreads. Previously, in the process of pursuing rapid expansion in asset size, it was difficult for banks to effectively adjust their debt structure. In the future, as the growth rate of scale slows down, the Bank of Communications is likely to continue to optimize its debt structure. The deposit cost ratio is currently significantly higher than the average of the four major banks, and there is room for improvement in structure and pricing. Currently, the deposit policy is within a sustainable interest rate reduction cycle. In particular, for personal savings deposits with standardized pricing, there is room for significant decline in interest rates in the future.
Investment advice: Strong dividend assets. The valuation is expected to converge to the average of major banks. Bank of Communications's current PB valuation is still significantly lower than that of major state-owned banks. Considering that there is considerable room for improvement in debt structures and cost ratios, net interest spreads are expected to bottom out first, and ROE is expected to converge to the average of major banks. At the same time, asset quality is expected to continue to improve, supporting the stabilization of profitability. We forecast a year-on-year growth rate of 0.9%, 1.2%, and 2.7% of net profit to the mother from 2024 to 2026, maintaining a dividend ratio of 30%, and calculating dividend rates of 5.8%, 5.9%, and 6.0% for A-shares. Based on the closing price on April 8, 2024, Bank of Communications gave a “buy” rating for 2024 A shares PB valuation of 0.50X and PE valuation of 5.65X. It is optimistic about the room for valuation repair.
Risk warning
1. Credit scale expansion falls short of expectations; 2. Asset quality fluctuates significantly; 3. Profit forecasting assumptions fall short of expectations.