One of the most disappointing performers in emerging markets—and where many have the most concerns—is state-owned Chinese banks. There remains a lively debate about the trustworthiness of the numbers and whether there will be a surge in non-performing loans stemming from a massive credit expansion over the last decade. These concerns have caused major Chinese companies to trade at these depressed valuations. Recent earnings announcements coupled with rising payments of cash dividends indicate that the problems many have forecasted have yet to materialize and these stocks may indeed represent significant investment opportunities.
Increase in Net Profits
The largest Chinese banks recently released their year-end earnings reports for 2013, and the reports largely beat expectations from a profitability standpoint. Below we examine the four largest Chinese banks by market capitalization.1 All four banks reported an increase in net profits of 10% or more compared to the previous year.2
• China Construction Bank – Net profit was Renminbi (RMB) 215 billion, up over 11% from 2012
• Industrial and Commercial Bank of China – Net profit of RMB 263 billion, which represented an increase of over 10% compared to the previous year
• Bank of China – Achieved an after-tax profit of RMB 164 billion for the year, measuring a year-over-year increase of over 12%
• Agricultural Bank of China – Reported its financial year 2013 net profit of RMB 166 billion, up 14.5% year-over-year
We also analyzed the return on equity (ROE) ratio, a common profitability metric of the Chinese banks mentioned above. The four banks averaged an ROE of 20.6%, which was (i) 11.6% higher than that of the developed world banks, (ii) 8.6% higher than the emerging market banks, and (iii) more than twice as profitable as their U.S. bank counterparts.
Valuation Dynamics of Chinese Financials
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