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Morningstar | ABC’s 1H Recorded Strong NIM Expansion and PPOP Growth

Narrow-moat Agricultural Bank of China's, or ABC's, first-half results delivered a robust preprovisioning operating profit growth at 16.7% from the year-ago period, which is probably the fastest growth among large Chinese banks. Such strong growth was boosted by net interest margin, or NIM, expansion, accelerating fee income growth and significant improvement in operating efficiency. ABC's improving trend in operating efficiency was contrary to most peers which saw difficulties in reducing the cost/income ratio as a result of slowing top line growth and rising technology investment. The 6.6% year-on-year net profit growth represented 56% of our full-year forecast, in line to deliver our full-year forecast which implies a 9% growth.

We retain our fair value estimate for A shares at CNY 4.20 but lower our H-share fair value estimate to HKD 4.80 from HKD 5.20 per share to reflect the latest CNY/HKD exchange rate. We believe the bank's H-shares are undervalued, trading at 19% discount to our fair value estimate and 0.77 times 2018 price/book. Along with major Chinese banks we cover, ABC is trading at the lowest level over the past three years due to the market's renewed credit quality concerns, amid climbing default risks and trade war fears. However, we've seen steady credit quality improvement and ABC has industry-leading provision level. The results confirmed our view that ABC will continue to outperform large peers in NIM expansion and operating efficiency in the near term, underpinned by its strong deposit franchise and growth momentum.

Similar to CCB, ABC's second-quarter fee income growth strongly rebounded to 19% from a 8% decline in the first quarter, boosting first-half fee income growth to 3%. Bank card, electronic banking-related fee income surged 14% and 38%, offsetting the 17% decline in agent sales as sale of insurance and bank wealth management products, or WMPs, were hampered by stricter regulations. Nonprinciple guaranteed bank WMPs balance contracted by 13.4% to CNY 1.19 trillion, due to the need to restructure their products to comply with new regulations.

ABC saw a strong NIM expansion of 11 basis points to 2.35%, boosting first-half net interest income growth to 11%, while the growth slightly dropped to 8% in the second quarter. This was attributable to a 13 basis point increase in average asset yield as ABC increased asset allocation to retail loans including home mortgage and credit card loans, and corporate loans in commercial service and transportation sectors. While average deposit costs merely rose one basis points. ABC's strong deposit base was intact despite intensifying competition. Average deposit balance rose 7.4% from 2017, doubling the growth of interest earning assets and representing 87% of total interest-bearing liabilities.

Unlike some large banks seeing significant rebound in overdue loans and special mentioned loans, ABC's credit quality continued to improve as measured by major indicators. Bad debt ratio fell 19 basis points to 1.62%, with bad debt balance contracting 8% from 2017. Growth in special-mentioned loans and overdue loans slowed to 1% and decline 6% from 2017. ABC saw a 18% contraction in loans overdue within 90 days while loans overdue more than 90 days rose 2% from 2017. Management attributed the increased growth to stricter regulations regarding the recognition of overdue loans. Manufacturing, trade-related, mining and property accounted for over 80% of total corporate bad debts. Credit costs rose to 1.2%, up from 0.9% in the first half and we expect full-year credit costs at similar level.