Bank of China (SHSE:601988, Financial), the $155 billion Beijing-based financial institution and the world's fourth-largest bank, reported a 0.48% decline in interest income to 144.8 billion yuan ($21.3 billion) and 0.06% increase in profits to 46.6 billion yuan in the first quarter (32.2% margin vs. 32% margin the same period last year).
Total return
Bank of China ADR shares have outperformed the broader Standard & Poor's 500 index so far this year with 13.3% total gains compared to the index’s 8.8% (Morningstar). The company underperformed the index in the past five years with 12.2% gains vs. the index’s 15.3%.
Valuations
Bank of China is undervalued compared to its peers. According to GuruFocus data, the bank had a trailing price-earnings (P/E) ratio 7 times vs. the industry median 14.3 times, a price-book (P/B) ratio of 0.8 times vs. the industry’s 1.2 times and a price-sales (P/S) ratio of 2.3 times vs. the industry’s 3.4 times.
The firm also had trailing dividend yield of 5.34% with 33% payout ratio.
Average 2017 sales and earnings-per-share expectations indicate forward multiples of 2.2 times and 7 times.
Bank of China
Bank of China was founded 105 years ago and headquartered in Beijing.
The bank is mainly engaged in the provision of banking and related financial services, including commercial banking business, investment banking business, insurance business, direct investments and investment management businesses, fund management business and aircraft leasing business, as well as others.
The firm mainly provides loans to individual and corporate clients.
In fiscal 2016, Bank of China generated 86% of its net interest income in Mainland China, 9.6% in Hong Kong, Macau and Taiwan, and the remaining in other countries.
The firm had six segments: Corporate banking, Personal banking, Treasury operations, Investment banking, Insurance and Other. (1)
Corporate banking
Corporate banking services to corporate customers, government authorities and financial institutions, including current accounts, deposits, overdrafts, loans, trade-related products and other credit facilities, foreign exchange, derivative products and wealth management products.
In 2016, net interest income in Corporate banking fell by 10.7% to 301.8 billion yuan (46% of unadjusted total) and profit before tax margin of 26.6% vs. 26.8% in 2015. (1)
Personal banking
Personal banking services are to retail customers, including savings deposits, personal loans, credit cards and debit cards, payments and settlements, wealth management products and funds and insurance agency services.
In 2016, net interest income grew 4% to 194.4 billion yuan (29.7% of unadjusted total) and profit before tax margin of 31.4% vs. 27% in 2015.
Treasury operations
Treasury operations consisted of foreign exchange transactions, customer-based interest rate and foreign exchange derivative transactions, money market transactions, proprietary trading and asset and liability management.
Further, the results of this segment include the intersegment funding income and expenses, results from interest-bearing assets and liabilities and foreign currency translation gains and losses.
In 2016, net interest income in this segment grew 8.3% to 153 billion yuan (23% of unadjusted total) and profit before tax margin of 27% vs. 55.4% in 2015.
Investment banking
Investment banking consists of debt and equity underwriting and financial advisory, sales and trading of securities, stock brokerage, investment research and asset management services and private equity investment services.
In 2016, net interest income in Investment banking fell 23% to 942,000 yuan and delivered profit before tax margin of 304% vs. 251.5% in 2015.
Insurance
Insurance underwrites general and life insurance business and insurance agency services In 2016, net interest income grew 25% to 2.7 billion yuan and reported profit before tax margin of 40% vs. 52.4% in 2015.
Financial metrics
Net interest margin
Net interest income is the difference between the revenue that is generated from a bank's assets and the expenses associated with paying out its liabilities (Investopedia).
In 2016, Bank of China reported a net interest margin of 1.83% compared to 2.12% in 2015.
Return on assets
Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets (Investopedia).
In 2016, the bank registered a ROA of 1.05% vs. 1.12% in 2015.
In the first quarter of 2017, ROA was 1.09% – a 0.06% reduction from the same period last year.
Return on equity
Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested (Investopedia).
In 2016, Bank of China recorded a ROE of 12.58% compared to 14.53% in 2015.
In the first quarter of 2017, ROE was 13.74% – a 1.03% reduction from the same period last year.
NPL Ratio
NPL ratio is the ratio of a number of nonperforming loans in a bank's loan portfolio to the total amount of outstanding loans the bank holds (eHow).
A nonperforming loan (NPL) is the sum of borrowed money upon which the debtor has not made his scheduled payments for at least 90 days. A nonperforming loan is either in default or close to being in default (Investopedia).
NPL ratio in the first quarter of fiscal 2017 was 1.45%. Meanwhile, NPL figures in 2014, 2015, and 2016 were 1.18%, 1.43% and 1.46%.
Capital adequacy in Tier 1 and Common Equity Tier 1
Tier 1 capital
Tier 1 capital consists of shareholders' equity and retained earnings. Tier 1 capital is intended to measure a bank's financial health and is used when a bank must absorb losses without ceasing business operations (Investopedia).
Under Basel III, the minimum tier 1 capital ratio is 6%, which is calculated by dividing the bank's tier 1 capital by its total risk-based assets.
The tier 1 capital ratio for the recent quarter was 12.04%. Meanwhile, the figures in 2014, 2015 and 2016 were 11.35%, 12.07% and 12.28%.
Common Equity Tier 1
Basel III requires banks to have the minimum Common Equity Tier 1 capital ratio of 4.5%.
The common equity tier 1 capital adequacy ratio for the recent quarter was 11.16%. Meanwhile, the figures in 2014, 2015, and 2016 were 10.61%, 11.1%, and 11.37%.
Sales and profits
In the past three years, Bank of China had average sales growth of 5.9%, profit growth average of 1.6%, and profit margin average of 35.7% (Morningstar).
Cash, debt and book value
As of March, Bank of China had 631.5 billion yuan in cash and due from banks, and 410 billion in borrowings with a debt-equity ratio of 0.28 times –Â same as the prior year period.
The firm had minimal to negligible goodwill or intangibles in its 18.9 trillion yuan assets while having a book value of 1.45 trillion yuan compared to 1.35 trillion yuan in the first quarter of 2016.
Cash flow
In the recent quarter, Bank of China reported 384.7 billion yuan in cash flow from operations compared to 150.7 billion yuan in cash outflows the same period last year. Despite the nearly flat profit growth, the company had increased cash flow in its balances with central banks, increase in placements from banks and other financial institutions and increase in due to customers.
Capital expenditures were 7 billion yuan leaving Bank of China with 377.6 billion yuan in free cash flow compared to 154.4 billion free cash outflow. 0.43% of this free cash flow was allocated for dividend payouts.
Meanwhile, the bank allocated 41.8% of its free cash flow to dividend payouts in the past three years on average. Bank of China also raised 110.6 billion yuan accumulatively in issuing shares in the same period of three years thus diluting its shareholders.
In the recent quarter, the bank also took in 8.3 billion yuan in borrowings, net repayments and other financing activities.
Conclusion
Bank of China exhibited overall flat growth in its recent first quarter operations. In the past the bank recorded declining profitability in terms of financial metrics used to assess financial firms while capital adequacy seemed to be improving.
Further, balance sheet remained leveraged while the bank continued to be cash rich. Bank of China also was able raise cash from issuing shares and borrowing in recent years.
Meanwhile, asking a 25% margin from the bank’s book value would indicate a value of 1.45 trillion yuan or 1.65 trillion Hong Kong dollars ($211.69 billion) compared to today’s market capitalization of 1.54 trillion Hong Kong dollars in the Hong Kong exchange.
However, using the same valuation translated into the dollar would indicate a 4% upside from today’s ADR market capitalization.
In summary, Bank of China shares is a hold.
Notes
(1) Me: I was not able to gather information per specific segment in the recent quarterly report.
Disclosure: I do not have shares in any of the companies mentioned.
