Investors bet Chinese bank stocks have further to go as economy improves, bad loans fall

Traders are re-rating Chinese banks, betting that the nation’s steady economic recovery will fuel a rally in the stocks that are cheaper than global peers by major valuation metrics.

Shares of Industrial & Commercial Bank of China and China Construction Bank, the nation’s two biggest lenders, and China Merchants Bank rose to their highest levels in a decade this week in Shanghai, while the stocks of Agricultural Bank of China set a record high.

Moreover, China’s first uptick in full-year economic growth in seven years and Chinese bank shares trading at a discount to global counterparts are a signal to investors that the stock boom will continue.

“The quality of the banks is improving and valuations are cheap,” said Wang Chen, a partner at Xufunds Investment Management, in Shanghai. “That is a very good combination for asset allocations. Judging by valuations, the banking stocks have the potential to rise further.”

China’s listed commercial banks are valued at an average of 1.14 times their book value compared with 1.37 times for the global lenders, according to data compiled Bloomberg. In terms of price earnings ratio, Chinese banks are half as expensive as their global counterparts, the data showed.

The sector has been long in the doldrums, with the stocks trading close to or even below their book values for most of the past decade. China’s slowing growth, coupled with dwindling external demand and excessive output in industrial products from coal to steel, prompted investors to sell the stocks fearing a rise in bad loans.

Now, investors are re-gauging the approach on how they value banking stocks. Gains in the sector have been accelerating this year on expectations that an uptick in China’s growth and a cutback in overcapacity will bolster earnings by curbing non-performing loans. The nation’s economic expansion quickened 6.9 per cent last year, the statistics bureau said on Thursday.

ICBC has gained 15 per cent in Shanghai this year, taking its price to book ratio to 1.27 times, and China Construction Bank has climbed 18 per cent, trading at 1.36 times book value. China Merchants Bank and Agricultural Bank have advanced at least 12 per cent.

“It is time to reassess China’s banking industry,” said Xiao Feifei and Ran Yuhang, analysts at Citic Securities, the nation’s biggest listed brokerage. “The banks already have a basis for a sustained expansion of valuations and the fundamentals tend to change.” They predicted a further 30 per cent gain in Chinese banking stocks as net interest margins stabilise and bad-loan ratios fall.

BOC International said Chinese banks’ earnings growth would probably increase to 7.7 per cent in 2018 from 5 per cent a year earlier, and the current stock prices were undervalued as the valuations take in the risk of more bad loans.

“The performance of banks is closely correlated to the macro economy,” said Li Yamin and Yuan Zheqi, analysts at the brokerage. “Banking stocks are expected to be on the upturn in 2018 amid a pickup in China’s economy.”