Photographer: David Paul Morris/Bloomberg

China's Bargain Bank Stocks Miss Out on Rally

Updated on
  • Tech, consumer shares favored as deleveraging hits lenders
  • While GAM avoids banks, Citi says credit angst is overplayed

Not even the cheapest shares in 13 years can lure investors to China’s banks.

On a price versus book value basis, Chinese financial firms are trading at the biggest discount since 2004 to both the MSCI China Index and their Asian peers. The stocks have underperformed all but two other industry groups this year.

While that’s spurred bullish calls from strategists and analysts alike, investors aren’t biting. Banks are being left on the shelf, even as a surge in Chinese equities triggers a round of bargain hunting, with stocks linked to old drivers of growth in Asia’s largest economy enjoying gains.

At the heart of investors’ reluctance to embrace bank shares is the country’s deleveraging campaign. China is tightening conditions in money markets to rein in a record debt pile built up after the global financial crisis. Higher funding costs will squeeze bank profitability, Fitch Ratings said last week, and there are recurring concerns over lenders’ balance sheets.

Bloomberg Intelligence says China’s bad loan woes will linger -- read more here.

“There’s kind-of a cap on valuations for financials,” said Jian Shi Cortesi, a fund manager in Zurich at GAM Investment Management, which oversees the equivalent of about $120 billion. “It’s rare that they trade above one times book value these days, and when they do, their shares tend to come down again.”

While the MSCI China Financials Index nudged above the value of its members’ assets last month, the price-to-book ratio has fallen back below one, where its been for most of the past year. Financials -- which make up about a quarter of the overall MSCI China gauge -- are still the fourth-highest rated by analysts, beating health-care shares, energy producers and property companies, among others, Bloomberg data show. Tech shares are the highest rated.

Consumer Play

“Other sectors will do even better if we have a broad-based economic recovery,” said Cortesi, whose China stock fund has beaten 95 percent of its peers in 2017.

JPMorgan Asset Management and Pictet Asset Management are singing a similar tune, sticking to consumer shares which are valued about 10 times the price-to-book ratio of financial stocks, according to data compiled by Bloomberg. All three firms like technology, which legendary emerging-market investor Mark Mobius has blamed for making the offshore Chinese equity market too expensive.

“The worry for the banks has always been the belief of their ‘true’ book value,” Pictet’s James Kenney said from London. “We see more compelling ideas in stocks benefiting from structural or cyclical growth.”

Read more on the outlook for China’s economy here.

Pictet’s $150 million China equity fund holds fewer bank stocks than are represented in the MSCI China, instead favoring technology and communications-sector shares, which trade at 9.7 times and 2.6 times book value, respectively. Financial shares rose from a one-month low on Wednesday as the broader index rallied 0.7 percent.

Earnings for Chinese financial stocks will contract for a second straight year, according to analysts’ estimates compiled by Bloomberg, running counter to the wider market, which is projected to see the biggest recovery in profit growth since 2010, the data show. Policy makers will probably be stricter on deleveraging than investors expect, which will weigh on earnings, Nomura Holdings Inc. strategists led by Wendy Liu said in a report this month.

Credit Suisse Group AG, however, is in the bullish camp.

The earnings outlook for Chinese banks is improving steadily, say Asia-based strategists Sakthi Siva and Kin Nang Chik, who are overweight the sector. The gap between Chinese banks’ valuations and their profitability -- as measured by return on equity -- is the highest among lenders in the Asia Pacific region, the strategists said in an April 4 note.

For Jason Sun, Citigroup Inc.’s chief China strategist, the concerns over banks’ balance sheets is overblown. He’s also overweight, saying two banks -- China Everbright Ltd. and Agricultural Bank of China Ltd. -- provide some of the biggest dividend yields in the MSCI China, according to a recent note.

That’s not enough for Tai Hui, chief Asia market strategist at JPMorgan Asset Management in Hong Kong. He tells clients to focus on companies exposed to the consumer.

“Chinese banks are a good tactical play for investors looking for yield -- but there are better ways to get your capital gains in the long-term,” he said. “They’re cheap because investors are pricing in the risk of credit deterioration, and my worry is that profits won’t come through.”

(Updates with Wednesday’s China trading in 10th paragraph.)
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