Bank of China:Transformer

Morphing into a regional player adds risk; move to O-PF

BOCHK’s 1H15 was broadly in-line with expectations but recentdevelopments in China and across the region are likely to weigh on its topline going forward. We cut our 15CL-17CL by 2-7%. We also await moreclarity with respect to the proposed disposal of NCB and the acquisition ofASEAN assets. We transfer coverage with a new HK$28.80 target price(previously HK$34) and lower our rating from BUY to Outperform.

P&L: margins disappoint but non-interest income delivers

1H15 attributable NPAT was up 7% HoH and 10% YoY. Its margin fell 11bpsHoH to 1.59% but non-interest income benefitted from opportunistic gains,strong brokerage, and other market-related income. Costs were contained(28% cost-to-income ratio), bad debts were higher but in-line withexpectations at 16bps of average loans and higher gains on investmentproperties was offset by higher minorities. The 1H15 DPS was disappointinglyin-line with 1H15 at HK$0.55.

Balance sheet remains solid at this stage

YTD loan growth is 7.3% while YTD deposit growth is 8.9%. The loan-todepositratio declined to 63.9% (2H14: 64.8%). Excess liquidity was placedinto shorter duration foreign currency liquid assets. Although the mainlandNPL rose, the group NPL ratio declined to 0.27% (2H14: 0.31%). Thecoverage ratio improved to 161% (2H14: 153%). The LCR was a solid 110%.

CET1 was broadly stable HoH at 12.4%. BVPS benefitted from sizeableproperty revaluations below the line. BVPS was HK$17.55.

Revising down 15CL-17CL EPS by 2-7%

Management was relatively optimistic on the outlook for 2H15. Howeverrecent market volatility and developments in China are likely to weigh on itstop line. We incorporate its 1H15 results into our numbers and revise downmargins through to 17CL. We also make small adjustments to bad debts in17CL and the dividend. Our DPS is in-line with the underlying payout ratiopolicy of 40-60%. We make no adjustments at this stage for either thepotential sale of NCB to Cinda in 2H15/16CL or the planned acquisition ofASEAN assets from its parent company.

Move from BUY to O-PF with a revised target price of HK$28.80

We value BOCHK using a target PB multiple derived using a Gordon growthmodel. The fundamental PB target is based upon a sustainable ROE of 14.5%,a COE of 11% and a terminal growth rate of 4%, for a target multiple of 1.5x.

We apply this to a 16CL BVPS of HK$19.46. Our revised target is HK$28.80(previously HK$34.00). We assume coverage with an O-PF recommendation.