BANK OF CHANGSHA(601577)：THREE-PRONGED STRATEGY TO UNLEASH EARNINGS GROWTH POTENTIAL

Investment positives

    We initiate coverage of Bank of Changsha Co. Ltd. (BCS) with an OUTPERFORM rating and a target price of Rmb9.80 (0.8x 2021e P/B).

    Why an OUTPERFORM rating?

    Starting from Changsha and expanding throughout Hunan province, we believe BCS has built advantages in corporate lending and microfinance businesses. As of 3Q21, BCS’ assets equaled Rmb786.6bn and loans totaled Rmb353.9bn (Hunan province represents 95% of total loans, within which Changsha accounts for around 60%). The Municipal Bureau of Finance and State-owned Assets Supervision and Administration Commission are controlling shareholders for a large proportion of BCS’ shareholders. As such, we believe BCS enjoys advantages in loan resources, low-cost corporate demand deposits and trusteeships, and agency business. BCS targets micro- and small-sized enterprises and individual businesses as well as rural markets. It has built close ties with small- and micro-sized enterprises as well as strong brand power. As of 1H21, BCS operated 343 branches, of which 183 county-level branches covered 86% of counties in Hunan.

    We believe Changsha’s transformation into a popular tourism destination will create opportunities for BCS. Changsha is a major industrial city in the mid-region of the Yangtze, with mature industrial, manufacturing, and transportation industries. Hunan province ranked No.9 in GDP among all provinces in China in 2020, with a growth rate of 7.6%. Changsha ranked No.15 in GDP among all cities with growth of 4.9%. In recent years, Changsha has been actively building its presence in emerging industries. Its tourism industry is booming, creating new opportunities for BCS’ financial services, in our opinion. BCS also launched a strategy to embrace consumer, technology and individual businesses, seeing rapid growth in consumer loans and those for high-end manufacturing and infrastructure construction.

    Retail, lower-tier markets, and risk control upgrades to unleash earnings growth potential. Historically, BCS relied on high asset pricing to secure its high ROA and ROE. It is now releasing three major transitions to maintain high profitability: 1) developing its retail business, providing consumer loans and wealth management (WM) services and expecting rapid growth in consumer loans and assets under management (AUM) for its retail business; 2) penetrating lower-tier markets (expanding presence in villages and counties and providing payment transactions, social insurance, and medical insurance collection and other rural financial services to fully develop low-cost debt business); and 3) upgrading risk control to improve asset quality. In 3Q21, BCS’ non-performing loans (NPL) ratio fell to 1.20%, and its provision coverage ratio rose to 275%. The bank seeks to improve its risk management via a digital transition, lowering its NPL ratio to 1.1% and raising its provision coverage ratio to 350% in 2023.

    How do we differ from the market　　The market doubts BCS’ asset quality indicators. However, as the bank is seeing steady progress in the reduction of existing risk, we expect it to upgrade its risk control with improving asset quality. We suggest watching BCS’ presence in county-level markets as it provides better financial services compared with local institutions including rural credit cooperatives. We expect its branches in counties to help acquire low-cost debt, expand retail clients, and stabilize profitability.

    Potential catalysts: Asset quality indicators improving; profitability stable and outperforms peers.

    Valuation and recommendation

    We estimate 2021 and 2022 EPS at Rmb1.57 and Rmb1.77, a CAGR of 15.5%. The stock is trading at 0.6x 2021e P/B. As BCS is already experiencing steady progress in the implementation of its three strategies with continued improvement in asset quality, we initiate coverage with a target price of Rmb9.80 (0.8x 2021e P/B), offering 24.7% upside. We assign an OUTPERFORM rating.

    Risks

    Unexpected declines in net interest margin (NIM), disappointing asset quality; weaker-than-expected growth in loans.