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Morningstar | ABC's Core Earnings Growth Leads Peers in 2018; Credit Quality Sees Strong Improvement

With 11.5% and 5.1% respective growth in revenue and net profits, narrow-moat Agricultural Bank of China's 2018 results were strong across the board. The results confirmed our view that ABC will continue to outperform large peers due to its low funding costs and improving operating efficiency in the near term, underpinned by strong deposit franchise and growth momentum. As the results were largely in line, we retain our fair value estimates at CNY 4.20 for the A shares and HKD 4.80 for the H shares.

The strong results were driven by faster-than-peer growth in fee income and net interest income. Furthermore, the cost/income ratio improved 169 basis points to 31.3%, versus 25-55 basis points of improvement for the other big four peers. ABC’s fourth-quarter net interest income growth decelerated to 4% from 9.5% in the first three quarters; we suspect this was attributable to a higher base in the year-ago quarter and lower new loan pricing for private enterprises and micro and small businesses. Average loan pricing climbed 14 basis points to 4.4%, in line with large peers. However, ABC's strong deposit franchise and solid foothold in rural markets resulted in a 5-basis-point decline in deposit costs to 1.39%, the lowest among peers. This was a strong testimony to the bank's funding cost advantage compared with peers' increases of 6-11 basis points as competition intensified.

The bank's H shares appear undervalued, trading at a 23% discount to our fair value estimate and 0.6 times 2019 price/book. In comparision, CCB and ICBC are trading at 0.7 times forward P/B. We believe the market has overlooked ABC's strong improvement in operating efficiency and enviable funding cost advantage. Also, the bad-deb ratio has improved significantly with a 22-basis-point decline to 1.59%, at par with large peers. These factors support our more optimistic outlook than the market; we believe ABC deserves a valuation level in line with CCB and ICBC.

ABC's preprovisioning operating profit growth maintained its lead at 16% versus the 5%-9% growth of large peers. The 7.2% fee income growth was a bright spot compared with peers, which saw growth below 4%. Thanks to the rising popularity of bank card payment and online banking services, fee income related to bank card and e-banking rose 13% and 35%, respectively, accounting for 28% and 21% of total income. Fee income related to wealth management business dropped 8% from 2017 as it was negatively affected by new asset management rules and shadow bank deleveraging. We expect such income will stabilize in 2019 as the regulatory impact gradually abates.

ABC's credit quality saw stronger-than-peer improvement, with the bad-debt ratio further falling 22 basis points to 1.59% and bad-debt balance dropping 2% to CNY 190 billion. The bad-debt formation rate increased to 0.96% from 0.59% on stricter bad-debt classification. Credit costs rose to 1.21% from 0.96% as the bank stepped up its bad-debt disposal and provision coverage climbed 44 percentage points to 252%, the highest level among the big four banks. Leading indicators including special-mentioned loans and overdue loans contracted by 7% and 9%, respectively, from 2017, making ABC the only bank to witness consecutive declines over the past three years among the big four peers.