Agricultural Bank of China (1288.HK)

Transcription

1 IPO Analysis Rating Target Price Subscribe HK$3.44 Agricultural Bank of China (1288.HK) Table 1:Details of Global Offering Details of Global Offering Number of Offer Shares under the Less than 25,411,765,000 Shares Global Offering Number of Hong Kong Offer Shares 1,270,590,000 Shares Number of International Offer Shares 24,141,175,000 Shares Offer Price Amount of fund Raising Nominal Value HK$2.88 HK$3.48 less than HK$ billion 1.00RMB Listing Date July 16, 2010 Market Value after listing HK$ 1, billion (base on an offering price of HK$3.48) Joint Global Coordinators China International Capital Corporation Hong Kong Securities Limited, Goldman Sachs(Asia), Morgan Stanley Asia, ABC International Joint Bookrunners and Joint Sponsors China International Capital Corporation Hong Kong Securities Limited, Goldman Sachs(Asia), Morgan Stanley Asia, Deutsche Bank AG, J.P Morgan, Macquarie, ABC International Source: Prospectus Table 2:Financial Highlight Year ended 31 Dec (million RMB) FY07 FY 08 FY 09 Analysts: Castor Pang Lewis Pang (852) (852) Revenue 179, , ,274 Gross Profit 77,447 52,071 73,742 Gross Profit Margin (%) 43.21% 24.66% 33.18% Profit attributable to shareholders 43,787 51,474 64,992 Net Profit Margin (%) 24.43% 24.37% 29.24% Diluted EPS (RMB) N/A N/A 0.25 Source: Prospectus Page 1

2 Investment Summary The Agricultural Bank of China (ABC) is the leading bank in China s countryside, providing corporate and personal banking services, discounted bills, and other wealth management related services to customers in both rural and urban areas. As of December 31, 2009, ABC had 23,624 domestic branches, 10,887 of which is located in urban areas and 12,737 of which is located in rural areas. As of December 31, 2009, ABC had RMB trillion in total assets, 23.6% of the combined total assets of the four State-owned commercial banks. ABC has RMB trillion in loans and RMB trillion in customer deposits; relative to all the banking institutions in China, ABC has a market share of 9.7% and 12.3% respectively, in the above categories. We believe ABC has the unique advantage in the countryside that would be beneficial to expanding their business foundation. ABC s interest income is expected to benefit from government s Sannong Policy, which lowered the cost of funding and the loan to deposit ratio, while the network of branches in across the rural areas of China brings economies of scale when promoting non-interest services. Assuming the required cost of equity for China s banking sector is 15.5%, while ABC s EPS would increase by 9.0% in 2010 and 35.3% in 2011, while that growth rate would first slow down to 17% in , and eventually maintain a steady CAGR growth of 9% afterward. We also assume that ABC would adopt a dividend payout ratio of 50% in the long term, we appraise a fair value of HK$3.444 per share based on the multistage dividend discount model, implying a 10.5X and 7.8X expected price to earnings in FY10 and FY11, or a 2.00X and 1.78X expected price to book ratio in FY10 and FY11. Since the H-share offering price range is between HK$2.88 and HK$3.48, the offering price of HK$2.88 has a potential upside of only 19.5%; if the share is offered at the price of HK$3.48, the offering price would be 1.0% higher than our expected fair price. We believe that the market trading volume would remain in a low level, and institutional investors are relatively conservative to the IPO, it is likely that ABC offering price would be close to the lowest bound of HK$2.88. Use of Proceeds After paying the offer related fee, the remaining proceeds from A-share and H-share offering will be used to enhance the capital base of Agricultural Bank of China (ABC). Page 2

3 Competitive Strengths 1) ABC is the leading bank in China s countryside, with 23,624 domestic branches: There are 900 million citizens living in China s rural areas, accounting for 69% of the total population. In 2008, the rural economy contributed 49.8% of China s total GDP. As the leading bank in those areas, the ongoing urbanization process is expected to improve the operating environment. ABC s business strategy focuses on the 900 million in rural areas, especially the 300 million upper to middle class customers. As the growth pace of the countryside is expected to be faster than the country-wide growth rate, ABC is expected to benefit from the development of the rural economy, leading to an improvement in profitability. 2) Countryside economy is expected to enjoy a faster growth than the urban economy: Countryside area is the business focus of ABC, among the 23,624 branches, 53.9% are located in the countryside area. From 2005 to 2009, China s economy achieves a respectful growth rate, GDP per capita increased from RMB 14,144 to RMB 25,125 during this period, implying a CAGR growth of 15.4%. The step up in household income increases the demand of banking service. During the period, although the disposal income per person in urban area growth by 13.1%, which is higher than the growth rate of 12.2% in countryside. However, from the income growth rate in countryside area and urban area in 2009 (which are 8.2% and 8.8% respectively), we can observe the difference in growth rate is narrowing, meaning that the economy growth of countryside economy can achieve the growth pace of urban area, driving a more significant increase in demand of banking service in countryside area. At the end of 2009, ABC had a total loan amount and total deposit amount of RMB 1,193.4 billion and RMB 3,034.6 billion in countryside area, representing a YoY growth of 43.4% and 20.7% respectively. 3) ABC enjoy a low cost of funding among the four State-owned commercial banks: ABC has an national network of branches providing various banking services to corporate and retail customers; as of December 31, 2009, ABC had approximately 320 million retail customers. Leveraging on the extensive distribution network in the rural and urban areas as well as the large customer base, ABC has a long-term advantage in the structure and cost of providing loans. At December 31, 2009, ABC s retail deposits accounted for 58.2% of the total deposits, the highest percentage among the four State-owned commercial banks, and providing ABC with a stable source of funding. ABC also has a greater percentage of demand deposits, accounting for 55.5% of the total deposits as of December 31, 2009, also the highest percentage among the large commercial banks. This deposit mix enables ABC to maintain lower cost of deposits. For the years ending Decembers 2008 and 2009, ABC s average domestic deposit costs were 1.98% and 1.48%, respectively, the lowest of the four State-owned commercial banks. Since deposit availability for all banks are still limited in the countryside, ABC is expecting to enjoy a lower cost of funding after expanding in the future. Page 3

4 4) Fast growing fee and commission based business: In addition to the traditional saving and lending business, ABC also provides other fee and commission based business, such as settlements, asset custody, bank cards, and bank assurance. In 2009, the transaction volume of ABC Renminbi settlement business was RMB trillion. As of December 31, 2009, ABC s assets under custody reached RMB trillion, the second largest among all commercial bank in China, while the value of ABC s insurance assets under custody was the largest among all commercial banks in China. In addition, ABC was consistently ranked first in the total number of bank cards issued as of the end of each year from 2006 to ABC had issued approximately 365 million bank cards as of December 31, Also in 2009, ABC collected RMB72.8 billion in new premiums from the sales of insurance products, the largest among all commercial banks in China. Given the national network of branches, combined with the large and diversified customer base, the fee and commission based business is expected to maintain rapid growth rate in the future. We believe that the contribution of fee and commission based business to ABC s total revenue will rise from 18.8% in 2009 to 20% or above, which is similar to the other three State-owned commercial banks. 5) Low loan to deposit ratio provide room for growth in lending business: To catch up the opportunity of the growth in countryside area, ABC will focus on developing the corporate and personal lending business in the areas. We expect ABC s total loan amount would raise significant according to their business strategy, at the same time, as ABC has a solid deposit foundation, we believe that the total loan amount would enjoy a stronger growth and push up ABC s loan to deposit ratio, which is expected to increase from 53.50% in 2009, to 53.98% in FY10 and 55.07% in FY11, bringing RMB billion and RMB billion net interest income in this two years. Since ABC s loan to deposit ratio are lower than the other three State-owned commercial banks, ABC is having larger room for growth in lending business, while the steady increase in loan to deposit ratio would be one of the main driving force of profit growth in the future. Cornerstone Investors ADM subscript H share of US$100 million; Cheung Kong Limited (0001) subscript H share of US$100 million; China Resources subscript H share of US$200 million; CTS Holdings subscript H share of US$150 million; Kuwait Investment Authority subscript H share of US$800 million; Qatar Investment Authority subscript H share of US$2.8 billion; Rabobank subscript H share of US$250 million; Standard Chartered Bank (2888) subscript H share of US$500 million; Seven Group subscript H share of US$250 million; Temasek subscript H share of US$200 million; United Overseas Bank Limited subscript H share of US$100 million. It is expected that the cornerstone investors would subscript base on the public offering price, and the lock-in period would be 12 months after listing. Page 4

5 Valuation Given their profitability and ability to handle the bad debt, after the disposal of non-performing assets in 2008 and listing on the Hong Kong and Shanghai Stock Exchanges, ABC s valuation should has the potential to grow in many other areas. However, we believe that ABC will remain focused on the banking business in rural areas, so that the operating costs, risk levers, and gross profits will not change fundamentally. Thus, we adopted a conservative approach to evaluate ABC s fair value price, applying the traditional price to book ratio (P/B) and dividend discount model. P/B valuation: Since ABC had disposed of non-performing assets amounting to RMB billion, and the future operation strategy is has been changed, we assume that the operation model will be similar to that of the other listed State-owned commercial banks. Hence the industrial average P/B ratio, or the P/B ratio of banks of comparable scale and operation model, can be applied in ABC s valuation. In the following section, we will compare ABC with the other three listed State-owned commercial banks with factors such as profitability, capital adequacy ratio, non-performing asset ratio, and total profit, followed by a regression model to appraisal ABC s fair price level under P/B valuation methodology. Profitability Comparison: By comparing the profit related figures of the four State-owned commercial banks in 2009, we find that ABC enjoys a clear advantage in loan-to-deposit ratio only. Since ABC currently has a loan-to-deposit ratio of 55.2%, an increase in the deposit reserve ratio by the People s Bank of China does not impact ABC s lending business significantly. In the other profit related figures, ABC has the lowest return on asset ratio among the four banks, 36 basis points lower than the average of the remaining three. However, although ABC s return on equity ratio and net interest spread is not the highest of the four, it is higher than the average of the remaining three. From Table 3, we find that ABC profitability level is not as high as that of China Construction Bank (CCB) and Industrial and Commercial Bank (ICBC), but slightly better than Bank of China (BOC). Thus, when only considering the profitability factor, we believe ABC s valuation should be at a comparable level to the other three banks. Page 5

6 Table 3:Revenue and profit comparison of the four Stated-owned commercial banks Average As of December 31, 2009 BOC ICBC CCB value of the ABC ABC other three performance banks Return to asset ratio 1.09% 1.20% 1.24% 1.18% 0.82% Weak Return to equity ratio 16.44% 20.14% 20.87% 19.15% 20.53% Strong Net interest spread 2.04% 2.16% 2.30% 2.17% 2.20% Strong Net interest margin 2.19% 2.26% 2.41% 2.29% 2.28% Similar Fee and commission net revenue to Weak 31.58% 17.82% 17.99% 22.46% 16.03% total operating revenue Cost to income ratio 37.15% 32.87% 32.90% 34.31% 43.11% Weak Loan to deposit ratio 71.76% 58.63% 60.24% 63.54% 55.19% Strong Source: Prospectus and annual report Capital adequacy ratio Comparison: On December 31, 2009, the capital adequacy ratio of ABC is the lowest of all State-owned commercial bank. ABC s capital adequacy ratio will increase significantly after the offering, and rise beyond the average level of the other three banks. As the three banks have not completed their right offering process, ABC s relative strength in capital adequacy level would depend on the details of the right offering plan. However, assuming that ABC can raise US$20 billion capital from the offering, ABC s capital adequacy ratio would improve significantly and rise above the level required by the regulation authorities. Thus based on the capital adequacy level, ABC s fair P/B ratio valuation should higher than the average level of the other three listed State-owned commercial banks. Table 4:Capital adequacy level comparison of the four Stated-owned commercial banks Average ABC As of December 31, 2009 BOC ICBC CCB value of the ABC 3 banks performance Core Capital Adequacy Ratio 9.07% 9.90% 9.31% 9.43% 7.74% Weak Core Capital Adequacy Ratio after listing* % Strong Capital Adequacy Ratio 11.14% 12.36% 11.70% 11.73% 10.07% Weak Capital Adequacy Ratio after listing* % Strong Total Equity to Total Asset 5.88% 5.76% 5.81% 5.82% 3.86% Weak Total Equity to Total Asset after listing* % Weak *Assume ABC will raise US$20 billion in A+H listing Source: Prospectus and annual report Page 6

7 Non-performing assets Comparison: After asset reorganization and disposal of non-performing assets, the non-performing asset ratio of ABC remains relatively high compared with other State-owned commercial banks. On December 31, 2009, the bad loan ratio of ABC reached 2.91%, 91% higher than the average of other three State-owned commercial banks. Thus, we believe that investors would require a decrease in valuation. Even after disposal of the non-performing assets, ABC s non-performing asset ratio remains higher than the average level of the other three Stated-owned commercial banks. Hence, ABC s fair valuation should be close to the lower bound of the industrial P/B band. Table 5:Non-performing assets comparison of the four Stated-owned commercial banks Average ABC As of December 31, 2009 BOC ICBC CCB value of the ABC 3 banks performance Bad loan Ratio 1.52% 1.54% 1.50% 1.52% 2.91% Weak Provision to total loan 2.30% 2.54% 2.63% 2.49% 3.06% Weak Provision coverage % % % % % Weak Source: Prospectus and annual report Total Profit and P/B ratio: In 2009, the total profit of the four State-owned commercial banks ranges from RMB 65 billion to RMB billion. Among them, ICBC achieved an annual profit of RMB billion, which is the highest among the four banks, thus ICBC also achieved a higher P/B ratio. In comparison, ABC only recorded a profit of RMB 65 billion, the lowest among the four banks. Table 6:Total Profit and P/B ratio comparison of the four Stated-owned commercial banks Average As of December 31, 2009 BOC ICBC CCB value of the ABC 3 banks ABC performance P/B ratio (market close at June 22, 2010) Total profit (100 million RMB) , , , Weak Source: Prospectus and annual report Page 7

8 Relationship between P/B ratio and P/E ratio: We formulated a regression model base on the historical P/B ratio and P/E ratio of the listed commercial banks. The result is shown in graph 1, where the relationship between the P/B ratio and P/E ratio is: P/B ratio = X P/E ratio In graph 1, the red line represents the long term relationship between the bank s P/E ratio and P/B ratio. CCB (0939), ICBC (1398), Bank of Communications (3328) and China Merchants Bank (3968) are above the red line, representing a slightly over-value of their P/B ratios. On the other hand, Minsheng Bank (1988) and Bank of China (3988) are below the red line, meaning that their P/B ratios are lower than the fair ratio. The three listed State-owned commercial bank have an average P/E ratio of 12X; according to the regression results, the fair P/B ratio of a State-owned commercial bank should be around 1.99X. Since we believe that ABC does not have a significant advantage over the other three State-owned commercial banks, the valuation of ABC should be at a similar level comparing with others, suggesting a P/E ratio of 12X and a P/B ratio no higher than 1.99X. Graph 1:Relationship between P/B ratio and P/E ratio of listed Chinese commercial bank Source: Bloomberg and Cinda International Multistage Dividend Discount Model We believe that ABC s profit growth rate will peak two years after listing and afterwards will slow down, hence we applied the multistage dividend discount model to estimate ABC s fair value. Assuming that ABC would benefit from government s Sannong Policy and enjoy a rapid growth in customer base, we predict that ABC s EPS would increase by 9.0% in 2010 and 35.3% in 2011, while that growth rate would first slow down to 17% in , and eventually maintain a steady CAGR growth of 9% afterward. In addition, we estimate the cost of equity for investors and payout ratio of ABC to be 15.5% and 50% respectively. The fair value of ABC under this model is HK$3.444 per share, implying a 12.77X FY10 expected P/E and 2.00X FY10 expected P/B. Page 8

9 Assumption on future growth: We believe ABC would benefit from government s Sannong Policy in the future, since ABC already has a well developed coverage in countryside area, the margin benefit for further expansion will be relatively low, thus after experiencing the rapid growth in 2008 and 2009, we expect ABC s total deposit growth rate in 2010 and 2011 would decrease to 10% from 22.96% in Besides, we expect ABC would focus on the retail loan and discounted note business in order to improve the company s profitability. Thus these two businesses would achieve a rapid development and induce a 13.80% and 14.32% total loan growth in 2010 and 2011 respectively, which would be higher than the overall deposit growth. Although we expect the interest margin would drop from 2.2% in 2009 to 2.0% in 2010, however, the loan to deposit ratio is expected to increase gradually from 53.50% of 2009 to 53.98% and 55.07% in 2010 and 2011 respectively, driving an increase in net interest income, where ABC s expected net interest income would be RMB billion in FY10 and RMB billion in FY11. Besides, ABC is working hard on their fees and commissions based business, thus we expect the net fees and commissions income would experienced a CAGR growth of 25% in FY10 and FY11. Combining the interest based business and the fees and commissions based business, we expect ABC s operating income would be RMB billion and RMB billion in FY10 and FY11 respectively, implying a growth rate of 18.5% and 8.7%. After disposing the non-performing asset in November, 2008, ABC had continued the provision possess for the non-performing asset, hence we believe that in short term, ABC would not experience a large scale asset provision, and the asset provision expense would gradually decrease in 2010 and 2011, where the asset provision expense to operating income ratio would decrease from 15.09% in 2010 to 6.94% in 2011, and operating cost to operating income ratio would maintain on a level between 43% to 45%. Table 7:Key assumption on ABC s operating performance E 2011E Deposit growth rate 15.32% 22.96% 10.00% 10.00% Loan growth rate (10.77%) 33.48% 13.80% 14.32% Bad loan ratio 4.32% 2.91% 2.50% 2.25% Cost to income ratio 45.30% 43.40% 45.00% 45.00% Loan to deposit ratio 49.45% 53.50% 53.98% 55.07% Interest of interest bearing asset 4.72% 3.41% 3.90% 3.90% Cost of interest bearing liability 1.89% 1.39% 1.50% 1.50% Dividend payout ratio % 50.00% Source: Prospectus and Cinda International Page 9

10 Risk Factors 30 Jun 2010 ABC has better growth prospects comparing with other listed Chinese commercial banks, especially if ABC adopts the business model of the other three State-owned commercial banks. However, investors should also keep an eye on the following risk factors. 1) Bad loan ratio remains high: On November 21, 2008, ABC disposed of certain non-performing assets with total principal amounts of RMB 815,695 million as of December 31, 2007; this disposal have greatly reduced ABC s bad debt risk, bringing the bad debt ratio down to 4.32% and 2.91% respectively in 2008 and However, the 2009 figure is still 139 basis points higher than the average level of the other three State-owned commercial banks (1.52% as of December 31, 2009). On March 31, 2010, the bad debt ratio of ABC dropped to 2.45%, 122 basis points above the average level of the other State-owned commercial banks (1.33%). Although the difference is decreasing, ABC still has a comparatively higher risk level. Table 8:Bad debt ratio comparison of the four Stated-owned commercial banks CCB BOC ICBC Average value of the 3 banks ABC December 31, % 1.52% 1.54% 1.52% 2.91% March 31, % 1.30% 1.35% 1.33% 2.45% Source: Prospectus and annual report 2) The slowdown in the Chinese economy brings adverse effects to banking sector s loan growth: Despite maintaining a positive growth rate, Chinese economic growth shows signs of slowing down, particularly under the cyclical fluctuation in the global economy. Although the economy has almost recovered from the US subprime mortgage crisis, the risk faced by the banking industry increased. This is due to the following factors: (i) As exports decreased, more companies suffered from a reduction in profit or even a loss. This causes certain industries suffering from a higher credit risks, and may lead to an increase in bank s bad loan ratio; (ii) There are more uncertainty regarding liquidity in the banking industry, resulted in difficulties in liquidity management; (iii) After the rebound in 2009, the Chinese economy face structural inflation, which combined with irrational performances in property market, caused the government to impose a series of contractionary policies. These included lifting the deposit reserve ratio and raise the minimum down payment ratio of second-house mortgage from 40% to 50%. The policies bring short term uncertainty to the banking sector. After the rapid rebound in early 2009, Chinese economic growth show sign of slowing down. As seen in graph 2, all industries maintain positive growth, with the overall economy recorded a growth rate above 8%. However, to prevent overheating economy and a possible asset bubble caused by the loosening monetary policy, from 2009 onwards, the PRC government imposed a series of macro-control policies to stave off a bubble. Page 10

11 In graph 3 and 4, the net increase in total loans has decreased significantly after its rapid growth in the first half of Since the government wanted to limit the net increase in total loan to below RMB 7,000 billion, the lending capacity in the second half of 2010 will be smaller than that of the first half, causing an adverse effect to the banking sector. In additional to the commercial banking function, the four Stated-owned banks will need to execute the monetary policies imposed by the government, which will result in a low profit growth rate. In addition, after reaching a peak in late 2009, banking sector s business climate index, confidence index and the demand of loan have been falling. If the demand of loans keeps diminishing in the second half of 2010, the banking sector would face a difficult operating environment. Graph 2:China s economy growth Graph 3:Monthly net increase in total loan Source: CEIC Source: CEIC Graph 4:YoY growth rate of total bank loan Graph 5:Banking Sector confidence index Source: CEIC Source: CEIC Page 11

12 3) ABC face a tight competition in the Chinese banking Sector: ABC has established a network of 2,048 country-level sub-branches and 22 business departments of tier-2-branches, providing various type of banking service to countryside area s customer. Besides, their market share in terms of total deposits and total loans are 12.3% and 9.7% of all PRC banking institution, respectively, which ranks third among all Chinese commercial banks. However, Chinese banking sector involve a large numbers of players. At the end of 2008, in addition to the four large commercial banks (ICBC, CCB, BOC and the Bank of Communications), there were 12 other national commercial banks, 136 city commercial banks, 22 urban credit cooperatives, 5,257 rural financial institutions, 28 foreign-owned banks, 196 banks from 46 foreign jurisdictions and a number of other banking institutions. The large commercial banks and other national commercial banks are the main competitors of ABC in the urban market, while the large number of city commercial banks, urban cooperatives and rural financial institutions will compete for the customer resources in countryside areas. Thus, ABC faces keen competition in both areas, and the operation costs will increase significantly if ABC intends to increase their profitability and market share. Graph 6:Market share in term of total asset (at the end of 2008) Source: Prospectus Graph 7:Market share in terms of total deposits (at the end of 2009) Graph 8:Market share in terms of total loans (at the end of 2009) Source: Prospectus Source: Prospectus Page 12

13 4) Lack of geographical diversity: In 2009, the Western, Central, and Northeastern regions account for 36.8% of all total loans, suggesting over-reliance on specific areas of economic development. This region also accounts for 50.7% of total non-performing loans, indicating that these areas fall into a high risk category. In the case of an adverse change in economic policies or a economic downturn in these areas the asset quality, financial condition and operating result would be significantly affected. In addition, loans are concentrated on specific sectors, which increase the overall risk. In 2009, 68.4% of loans were grouped into the following four categories: manufacturing, real estate, power/fuel/water supply, and transportation/postal services. In addition, 63.1% of personal loans and 16.7% of all loans were mortgages for housing, or RMB billion out of RMB 2, billion in total loans. Taking the loan to real-estate developers into account, the loans related to properties contributed 31.1% of the total loans. Table 9:ABC s loan portfolio as of December RMB million RMB million RMB million % % % Cooperate loan 2,761,157 2,359,297 2,968, Notes financing 204, , , Personal loan 491, , , Others 17,705 19,234 27, Total 3,474,174 3,100,159 4,138, Source: Prospectus Table 10:ABC s personal retail loan portfolio as of December RMB million RMB million RMB million % % % Mortgage loan 298, , , Loan to private business 92,758 78, , Personal consumption loan 40,090 42,299 85, Credit card balances 4,417 7,901 14, Others 55,074 16,339 85, Total 491, , , Source: Prospectus Page 13

14 5) Although the coverage of non-performing assets increased, but it has not yet reached the industry average: Since 2008 the global financial crisis has generated more obvious impact on the mainland economy, the quality of bank loan assets declined. To accommodation with this bearish factor, the non-performing assets provision coverage of the ABC went from 93.4% in 2007 to 105.4% in 2009, an increase of 12 percentage points in two years. However, this figure is still low compared to other banks. Coverage in 2009 for the China Merchants Bank (3968.HK) and Minsheng Bank (1988.HK) reached 246.7% and 206.0%, respectively. In 2010, the economy show sign of slowdown, and part of the large amount of loans provided by the banking sector in 2009 is invested in the high-risk industries. With the government pressure to prevent a property bubble, the asset quality would worsen, and we believe that the banking industry would further increase coverage of non-performing assets. As the coverage of ABC is still low even after the disposal of non-performing asset in 2008, with the decline in overall asset quality, we believe that the need for ABC to cover non-performing assets will increase in 2010, which will cause the overall profitability to decline. Table 11:Non-performing asset coverage ratio of China s commercial bank % % % ABC Industrial and Commercial Bank of China (1398.HK) China Construction Bank (0939.HK) Bank of China (3988.HK) Bank of Communications (3328.HK) China Merchants Bank (3968.HK) China CITIC Bank (0998.HK) China Minsheng Bank (1988.HK) Average of the four State-owned banks Average of major banks in China Industry Overview History Since the late 1970s, several of the PBOC s commercial banking functions were separated from the PBOC s central bank functions. The ABC, BOC, the CCB and the ICBC have gone on to become the main service banks in the industry. The Big Four were designated to specialize in agrarian financing, foreign exchange and trade finance, construction and infrastructure financing and urban commercial financing, respectively. Page 14

15 In the mid-1980, a number of new commercial banks and non-bank financial institutions were set up, but only a few were allowed to offer nationwide commercial banking services. In 1994, the PRC government established three policy banks: China Development Bank, The Export-Import Bank of China, and Agricultural Development Bank of China, to assume most of the policy lending functions of the Big Four. Accordingly, the Big Four started to be transformed into state-owned commercial banks. In 1997, after the Asian financial crisis, the PRC government adopted a number of measures to improve the quality of China's banking sector's assets and increase their capital base. In 1999, the PRC government established four wholly state-owned financial asset management companies, which received RMB 1,393.9 billion of non-performing loans and other impaired assets from the Bing Four and China Development Bank. In 2001, China joined the World Trade Organization and started to gradually open its banking sector to foreign financial institutions. Between 2003 to 2005, Huijin made a capital contribution to BOC, CCB, Bank of Communications and ICBC. In 2008, Huijin made a capital contribution of approximately US$19 billion to ABC, and ABC restructured and transformed into a joint stock limited liability company. Subsequent to the disposal of non-performing loans and equity contribution of Huijin, Bank of Communications, CCB, BOC, and ICBC introduced domestic and foreign strategic investors and listed their shares on both the Shanghai Stock Exchange and Hong Kong Stock Exchange. Meanwhile, many other national commercial banks and a number of city commercial banks have also introduced strategic investors, raised capital from shareholders to strengthen their capital bases, and successfully listed their shares on domestic or overseas stock exchanges. By adopting international practices, they have improved their asset quality and profitability. Industry Status Due to the rapid growth of China's economy, the increasing demand for banking services by businesses and residents gave the banking industry a great growth opportunity. Sarting from 2003, state-owned commercial banks launched a series of reform and integration. China's banking sector improved the corporate governance and risk management abilities, enhanced capital strength, increased profitability and brand value, and significantly increased market credibility. Graphs 9, 10 and 11 show the total amount of loans, deposits and assets have maintained a steady growth in recent years. From 2003 to 2009, the banking system's total loans, total deposits and total assets have experienced a CAGR growth of 17.2%, 19.6% and 18.7%. Therefore, short-term reducing in loans demand should not affect the healthy growth of the Chinese banking industry in the long run. Page 15

16 Graphs 9:Total Loans Graph 10:Total Deposits Source: CEIC Source: CEIC Graph 11:Total Assets Source: CEIC During this period, the quality of assets improved greatly. Non-performing loans of commercial banks went from 12.4% in the first quarter of 2005 to 1.4% in the first quarter of this year, while the major commercial banks have gradually increased coverage of bad loans to 170.2% by the first quarter of this year. The Chinese banking sector has not been significantly impacted by the global financial crisis, and still maintains healthy growth. Page 16

17 Graph 12:Non-performing Loan Ratio Graph 13:Non-performing Loan coverage ratio by Major Commercial Banks Source: CEIC Source: CEIC Despite the movements towards a more competitive environment, as of late 2009, the five largest commercial banks, the Agricultural Bank, Industrial and Commercial Bank of China, Bank of China, the Construction Bank and Bank of Communications, accounted for 53.8% of total banking assets in China, while the other 12 national commercial banks accounted for only 14.1% of total assets. It is unlikely that the five leading commercial banks will be shaken from their position. Industry Trends Rapid growth of countryside area financing China s countrywide area are areas designated as countries or country-level cities under China s administrative division unit. As of December 31, 2008, there were 2,003 countries and country-level cities in China, accounting for 95.2% of the total area and 69.8% of the total population of China. While the PRC government is promoting the process of urbanization and industrialization, China s urbanization rate increased to 45.7% in 2008 from 36.2% in The urbanization process induced the increase in demand of property and durable consumption goods, combining with the shift in economic structure to the secondary and tertiary industries, the countryside economy experience a rapid growth. Besides, the PRC government has undertaken a number of policy initiatives aiming to promote agricultural production, rural development and income growth for farmers, which have played a significant role in promoting countryside area economic growth. The government expenditure related to Sannong increased by 21.8% to RMB billion in 2009 from RMB billion in 2008, which in turn increased by 37.9% from At end of 2008, the total loan amount of all countryside financial institution amount up to 5,999.6 billion, contributing 18.7% of the national total loan amount. From 2005 to 2008, the loan amount in countryside area experienced a CAGR growth of 16.0%, slightly above the nation-wide loan amount growth rate of 15.7%. However, the overall countryside area banking market currently remains underserved. In 2008, ratio of countryside area loans to the total countryside area GDP was 40.2%, compared with a loans-to-gdp ratio of 171.5% for the urban areas. Thus from 2009, the PRC government had launched the policy included the Page 17

18 Provisional Measures on Administering Fund for Rewarding Increases in Agriculture-related Loans by Country Area Financial Institutions, the Notice on Policies for Pretax Deduction of Loss Provisions for Agriculture-related Loans and SME Loans Made by Financial Enterprises, the Notice on Issues Relating to Write-off of Non-performing SME Loans and Non-performing Agriculture-related Loans, the Notice on Rural Finance Tax Policy and the Notice on Matters Relating to Furthering Agricultural Bank of China s Country Area Banking Division Reform on a Pilot Basis. These policies aimed to improve the operating environment for countryside area financing institutions and expand the range of financial products and services available in the countryside area. Personal banking services and non-traditional banking services are the key of banking sectors growth The income level of Chinese citizens maintain a steady growth, during 2005 to 2009, the disposal income per person in urban areas and countryside areas had a CAGR growth of 13.1% and 12.2% respectively, driving up the demand on mortgage loan, bank cards and personal wealth management services. In , the total personal loan amount achieved a 23.6% CAGR growth, which is significantly higher than the nation-wide loan growth of 19.6% in the same period. Besides, the number of bank cards issued achieved a 46.1% CAGR growth, reflecting the huge demand on related services. Besides, a new market of wealth management services has emerged as a result of the rapid increase in household wealth and an expanding class of wealthy individuals. Commercial banks have started to offer customized and professional wealth management services to mid- to high-end customers, such as asset allocation, dynamic wealth management and corporate finance advisory services. Following the establishments of private banking business be several foreign banks, domestic commercial banks have also set up their own private banking departments and start to increase their market position in private banking services to high net worth individuals. Since the PRC government strives to increase the disposal income of individual, it is believed that the demand on personal banking would enjoy a steady and rapid growth. Graph 14:Personal loan amount Graph 15:Numbers of bank card issued Source: Prospectus Source: CEIC Page 18

19 In addition to growing traditional banking products and services, the PRC financial services industry has in recent years expanded financial product and service offerings in areas such as financial leasing, fund management and insurance. As of December 31, 2008, 7 Chinese commercial banks had jointly invested in or established financial leasing subsidiaries and 8 Chinese commercial banks, included ABC, have established fund management subsidiaries. As of December 31, 2008, bank-owned fund management companies commanded a market share of 12.4% in terms of the total net assets under management in China. Besides, the CBRC promulgated the Pilot Administrative Measures for Commercial Banks to Make Equity Investments in Insurance Companies, permitting commercial banks to invest in the insurance industry. As banks continue to expand their financial product and service offering in non-traditional areas, cross-selling financial products across a bank s integrated branch network has become an important way for banks to increase their fee and commission income. In 2009, according to the information made publicly available by China s 14 listed banks, total fee and commission income of these banks accounted for 16.3% of their total income, compared to 6.4% in However, this is still substantially lower than that of the mature overseas banks, which fee and commission income contribute almost 50% of their total income, thus fee and commission income still have a huge growth potential. Growth Potential ABC is one of the four major state-owned commercial banks: As one of the Big Four, ABC has the most prominent role in the countryside, and in contributing to local rural economic development, thus ABC had developed a close relationship with the business entities in the countryside area. As the PRC government aimed to narrow the economic gap between the urban areas and the countryside, we believe that PRC government s policy would be more favorable to the rural areas. Given the background and position of, ABC would become the most beneficial bank from the overall economic growth of rural areas. Urbanization in rural areas has been accelerated: It has been almost thirty years since the economic reform in China, but the majority of the population still live in rural areas. According to 2009 statistics, 53.4% of the population still live in rural areas, while the urbanization ratio is only 46.59%; in comparison, more than 70% of the population live in urban areas in most industrialized countries. With the expectation that China's urbanization rate will accelerate, the proportion of rural area s economic activity to national GDP will increase. Therefore, as the major bank in rural areas, the ABC will benefit greatly from this development, in particular through personal loans; the ratio of personal loans to total loans (20.7% in 2009) is expected to raise and bring up the total profit. Page 19

20 Graph 16:Urbanization trend of China Source: CEIC ABC is widely established in China: The bank had over 23,600 branches in China, where the proportion of branches in urban areas to that in rural proportion is 0.854:1, allowing ABC to enjoy the benefit from the economy growth of both the urban area and the countrywide area. ABC participates in the interest based business and the fees & commissions based business. These activities require a sales team to promote, thus the existing extensive network provide a bright growth prospect for the interest based business and he fees & commissions based business. There is increasing demand for personal banking products and services: The rapid economic development of China and the current extensive customer network have allowed the non-banking businesses, such as credit card, insurance, custody and agency services, to utilize the banking network for promotion. We notice that the China s banking institutions are having an expanding business scope, thus the type of services available increased. We believe that the demands for such services will rise, increasing the absolute amount and relative importance of non-interest income. For example, ABC s net non-interest income rose from RMB billion in 2007 to RMB billion in 2009, representing a 54.9% growth and a 24.5% CAGR growth. Base to the current situation, we expect that fee and commission income to be doubled in the next four years. The non-performing asset ratio will gradually decline: The Agricultural Bank of China has been affected by investors worried about its bad debts and high levels of non-performing loans problem. However, on November 2008, the bank had disposed RMB billion non-performing assets, and began monitoring loan approval procedures, gradually lowering the non-performing loan ratio and improving the asset quality. Similar situation have been happened in the past with the other three State-owned banks, where their non-performing asset ratio had reduced significantly after listing. We believe the Agricultural Bank of China will also have a similar opportunity, so that the non-performing loan ratio will fall in the future. Page 20

21 Low loan-to-deposit ratio increase interest income: The loan to deposit ratio for the ABC has been higher than the other three State-owned commercial banks, mainly because of its operational characteristics in the countryside areas. In the past, rural economic development was slow and characterized by a lack of large corporate enterprisers, keeping the banks' loan-to-deposit ratio remains below 50%. However, after the offering, ABC will focus on the development of rural areas, along with the PRC government s "Sannong policy, the deposit-to-loan ratio, which was 53.5% in 2009, is expected to rise to 54.0% in 2010 and 55.1% in 2011, bringing RMB billion and RMB billion net interest income in this two years. ABC is having larger room for growth in lending business, while the steady increase in loan to deposit ratio would be one of the main driving force of profit growth in the future. Table 12:2007 to 2011E Income Statement Overview for ABC E 2011E RMB million RMB million RMB million RMB million RMB million Interest Income 250, , , , ,315 Interest Expenses (85,852) (121,852) (114,508) (135,488) (149,809) Net Interest Income 164, , , , ,505 Net fees and commission income 22,995 23,798 35,640 44,550 55,688 Other net income (3,727) (9,785) 6, Operating income 183, , , , ,193 Operating expenses (74,620) (110,175) (109,567) (114,447) (118,529) Provisions for impairment losses (30,574) (51,478) (40,142) (40,000) (20,000) Share of losses of an associate 0 (14) Profit before tax 78,257 52,349 73, , ,664 Income tax expense (34,470) (896) (8,926) (22,126) (29,933) Net profit 43,787 51,453 65,002 88, ,731 Source: Prospectus, Cinda International Page 21

22 Table 13:ABC s operational and valuation ratio Earning per share (RMB) Dividend per share (RMB) ROE (%) % 21.6% Book value per share (RMB) (5.98 ) Book value per share (HKD) P/B (base on HK$2.88 offering price) X 1.47X P/B (base on HK$3.48 offering price) X 1.78X P/E (base on HK$2.88 offering price) X 7.81X P/E (base on HK$3.48 offering price) X 9.44X Dividend Yield (base on HK$2.88 offering price) % 6.40% Dividend Yield (base on HK$3.48 offering price) % 5.30% Source: Prospectus, Cinda International Page 22

23 Table 14:2007 to 2011E Balance Sheet Overview for ABC E 2011E RMB million RMB million RMB million RMB million RMB million Loans to customers, net 2,709,192 3,014,984 4,011,495 4,582,746 5,257,102 Investment securities and other financial assets, net 1,309,107 2,309,077 2,616,672 2,684,500 2,684,500 Cash and balances with central bank 937,014 1,145,884 1,517,806 2,094,313 2,446,798 Deposits with banks and other financial institutions, net 16,432 62,668 61,693 62,000 62,000 Placements with banks and other financial institutions, net 52,498 44,479 49,435 50,000 50,000 Financial assets held under resale agreements 144, , , , ,000 Other assets 136, , , , ,357 Total assets 5,305,506 7,014,351 8,882,588 9,807,625 10,851,757 Deposits from customers 5,287,194 6,097,428 7,497,618 8,247,380 9,072,118 Deposits from banks and other financial institutions 296, , , , ,000 Placements from banks and other financial institutions 30,375 34,131 26,312 30,000 30,000 Financial assets sold under repurchase agreements 73,391 35, , , ,000 Debt securities issued 4,154 5,150 55,179 55,179 55,179 Borrowings from central bank 150, Other liabilities 190, , , , ,885 Total liabilites 6,033,111 6,723,810 8,539,663 9,311,916 10,296,182 Paid in/share capital 121, , , , ,794 Total reserve (4,597) 18,423 23,002 66,740 66,740 (Accumulated losses)/retained earnings (844,620) 12,022 59, , ,934 Equity attributable to equity holders of the Bank (727,605) 290, , , ,468 Non-controlling interests Total Equity (727,605) 290, , , ,574 Total Equity and liabilities 5,305,506 7,014,351 8,882,588 9,807,625 10,851,757 Source: Prospectus, Cinda International Page 23

24 Rating Policy Rating Definition Buy Outperform HSI by 15% Stock Rating Neutral Between -15% ~ 15% of the HSI Sell Underperform HSI by -15% Accumulate Outperform HSI by 10% Sector Rating Neutral Between -10% ~ 10% of the HSI Reduce Underperform HSI by -10% Analysts List Castor Pang Research Director (852) castor.pang@cinda.com.hk Christina Ngai Research Analyst (852) christina.ngai@cinda.com.hk Hayman Chiu Research Analyst (852) hayman.chiu@cinda.com.hk Frankie Chan Research Assistant (852) frankie.chan@cinda.com.hk Lewis Pang Research Assistant (852) lewis.pang@cinda.com.hk Barry Chan - (852) barry.chan@cinda.com.hk Michael Yuk - (852) michael.yuk@cinda.com.hk Analyst Certification I / We Castor Pang hereby certify that all of the views expressed in this report accurately reflect my / our personal views about the subject company or companies and its or their securities. I / We also certify that no part of my / our compensation was / were, is / are or will be directly or indirectly, related to the specific recommendations or views expressed in this report / note. Disclaimer Cinda International may participate in the IPO of Agricultural Bank of China. This report has been prepared by the Research Department of Cinda International Holdings Limited (00111). Although the information and opinions contained in this report have been compiled or arrived at from sources believed to be reliable, Cinda International cannot and does not warrant the accuracy or completeness of any such information and analysis. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Recipients should understand and comprehend the investment objectives and its related risks, and where necessary consult their own financial advisers prior to any investment decision. The report may contain some forward-looking estimates and forecasts derived from assumptions of future political and economic conditions that are inherently unpredictable and which carry uncertainty. Any opinions expressed in this report are subject to change without notice. The report is published solely for information purposes, it does not constitute any advertisement and should not be construed as an offer to buy or sell securities. Cinda International will not accept any liability whatsoever for any direct or consequential losses arising from usage of any of the materials contained in this report. This document is for the use of intended recipients only, and the whole or a part of this report should not be reproduced to others. Page 24