Bank of China (OTCPK:BACHF) (OTCPK:BACHY) is one of China’s largest state-owned banks, providing banking and financial services in mainland China and internationally.According to Forbes, Bank of China provides the following services Banking and financial services: “Corporate banking business, personal banking business, treasury business, investment banking business, insurance business, etc. The company was founded on February 5, 1912 and is headquartered in Beijing, China.” It operates in more than 62 countries around the world.
In this article, I will explain my view on Bank of China’s earnings after the third quarter of 2023. I also provide an outlook for the remainder of 2023 and beyond.
In preview, I believe Bank of China is currently overvalued by c. 4.8%. Although its safe yield is as high as 9.5%, its share price may weaken further due to the uncertainty and challenging macro environment.I advise potential investors to be patient Waiting for a better entry point will give the Chinese economy time to regain its footing.
Overview of Bank of China’s recent results
The global banking sector first faced some turmoil during the pandemic, and now, post-pandemic, rising interest rates, high inflation and a possible recession have become long-term problems. In China, we can also add to the list of challenges a government crackdown on the debt-ridden real estate sector causing major disruption. But fortunately, the impact of the real estate industry on Chinese banks is relatively small.
Despite these turbulences, Bank of China has been growing year-over-year profits and earnings per share over the past few years.
Interestingly, however, this performance has not translated into share prices.
As can be seen from Seeking Alpha’s stock price summary, in the past five years, despite experiencing several storms and continuing to improve net profit and earnings per share, Bank of China’s stock price has fallen by -23.6%.
Dividend cuts also don’t explain this underperformance, as the dividend history and cost yield charts show. Over the five-year period, Bank of China’s year-end yields ranged from 6.4% to 16.3%. I also checked the shares outstanding to see if there was significant dilution (it was not the case), as the shares outstanding have remained almost the same over the past 5 years.
2023 Third Quarter Interim Results
During the August 30 earnings call, management divided its performance summary into four parts:
- Financial efficiency: Operating income increased by 8.92% year-on-year to RMB 319.7 billion (USD 46.3 billion), net interest income increased by 4.75% to RMB 234 billion (USD 33.9 billion), and net fee income increased by 4.34% to RMB 46.4 billion Yuan (USD 6.7 billion). Profit after tax reached RMB 128 billion (USD 18.5 billion), a year-on-year increase of 3.4%.
- Profitability Efficiency: Net interest margin fell to 1.67% from 1.76% in the first half of 2022, as the government required China’s large banks to “support the development of the real economy” and domestic RMB loan interest rates fell (more on this later).
- Assets and liabilities: Bank of China’s assets increased by 7.59% year-on-year, which was higher than the year-on-year growth of loans by 9.75%. Deposits also increased by 11.13%. The governor of the Bank of China said on an earnings call that RMB deposits and loans hit a record high.
- Risk Resistance: Bank of China’s “risk resistance” has also improved. One of the bank’s key indicators, the “non-performing loan ratio”, fell to 1.28%, while another key indicator, the “provision coverage ratio”, reached 188.39%. Finally, Bank of China’s CAR (capital adequacy ratio) reached 17.13%, which is a safe level.
Overall, I think their year-to-date results are solid. These results should be interpreted within the broader context of the Chinese economy. After a brief period of growth following the coronavirus “reopening” at the beginning of the year, all major economic indicators have steadily worsened. Therefore, I believe Bank of China is performing very well in a challenging macro environment.
Outlook – Fiscal Year 2023 and Beyond
I think the outlook for fiscal 2023 is roughly the same as the outlook for the first half. Beyond that, one also needs to understand the state of the Chinese economy, which is difficult to predict. The government is trying to shift the economy from one led by (government) investment to one led by domestic consumption. The goal is to get individuals and families to save less and spend more. Challenges with health care and pension regulations make this difficult to achieve. Nonetheless, I do believe that in the long run, once the Chinese government puts their mind to it, they will make it happen.
So for the Bank of China, I think the most important thing is to make sure that they do all the right things to benefit once the macro and political environment improves.
Going forward, Bank of China will focus on the following key priorities:
- “Support the real economy”: As one of the largest state-owned banks, the Bank of China is an extension of the government and a tool used by the government to influence and implement monetary policy. This is very different from Western retail and commercial banks. In order to stimulate the sluggish economy, the Bank of China has followed state instructions to provide financing at lower interest rates to support key areas of the Chinese economy. Examples of these areas include construction, manufacturing, industry, the ‘energy transition’, technology and innovation and SMEs, as well as promoting the ‘shared prosperity’ agenda beyond major cities.
- Bank of China is working to strengthen its core pillars, including improving its assets, liabilities, loans and deposits, and improving key risk indicators stated in its recent performance announcement.
- Related to its core is their ongoing digital transformation to improve efficiency and enhance customer service.
- In addition to its core business, Bank of China is also pursuing multiple key regions and projects that support national goals, including the Belt and Road Initiative and the South China Greater Bay Area.
Overall, I believe Bank of China is doing the right things and its efforts are not being recognized in its stock price. I’d like to see these goals pay off in continued profit growth, and hopefully higher dividends in the future. I think the recent underperformance is more a result of China and the global economy, and fundamentally it looks like Bank of China is moving in the right direction. As an investor in state-owned enterprises, you cannot avoid policy intervention, and Bank of China is clearly investing heavily to support government policies. One benefit of state ownership is that dividends can be very safe.
Looking at the broader competitive landscape, I compared Bank of China’s share price performance over the past five years with that of some of its major peers.
As can be seen from the chart above, the market has not treated China’s major banks very well in the past five years, but relatively speaking, Bank of China’s performance is slightly better than other banks.
From the perspective of relative valuation, Bank of China’s valuation is relatively reasonable compared with its major peers, and its non-performing loan ratio is generally good. To me, this suggests there is relatively little reason to worry.
Valuation-Dividend Discount Model
While valuing banks is difficult, I think it makes the most sense to value Bank of China using the dividend discount model, as the main reasons to invest in this stock are its high yield and dividend stability.
As you can see above, based on a cost of equity of 12% (from Capital IQ), I think Bank of China is currently trading 4.8% overvalued. I use a year-over-year dividend growth rate of 2.5% because that is the average growth rate over the 10 years from 2012 to 2022. Therefore, I have a “hold” rating on Bank of China. If I didn’t already own Bank of China shares, I would wait and see how the macro environment, especially in China, develops before buying any shares. Since I already hold shares in BOC, I would look for a further correction (down 5-10%) before adding more shares. Since Bank of China only pays dividends once a year in July/August, any potential dividend hike won’t be announced until next year. There will be more information on developments in China and whether there will be a dividend increase. This might make this stock a potential “buy” for me.
Risks and Disadvantages
There are two main risks for Bank of China:
- General “China Risk” – As a state-owned bank, Bank of China must support policy objectives that may not be in the financial best interest of non-government shareholders. This risk is difficult to quantify, and I believe that only if you can adapt to this risk can you invest in any major Chinese company.
- The economic environment in China – I don’t think this risk is any different than macroeconomic risks in the U.S., Europe or globally. Since we cannot predict what will happen, a severe recession in China, Asia or globally could have significant impacts. To mitigate this risk, I would advise any potential investor not to make large bets, but to make smaller bets and average out the cost over time. Especially for Bank of China, I think there is no need to rush because dividends are only paid once a year.
Based on dividend discount analysis, I believe Bank of China is currently trading at a 7.4% premium to its fair value. Bank of China has performed in line with and arguably slightly better than its major peers, and its valuation is quite reasonable in relative terms. Although Bank of China offers a safe and incredible yield of 9.5%, its stock price may weaken further due to uncertainty about China and the global economic environment. I would advise potential investors to be patient and wait for a better entry point to give the Chinese economy time to regain its footing.
I plan to start adding to the position around $0.30 per share.
Notes on investing in this stock: While BOC is trading at $0.34 per share at the time of writing, the minimum stock lot size is 1,000 shares, making the minimum purchase value at current prices $340.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.