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Morningstar | PSBC’s 2018 Net Profit Growth Slowed, Strong Growth Momentum and Solid Deposit Base Remained Intact

No-moat Postal Savings Bank of China’s, or PSBC’s, 2018 net profit growth of 9.8% was lower than our expectation for mid-single digit growth. We believe the slower bottom-line growth was primarily a result of increased credit costs in response to the regulator’s call for strict bad debt classification and prudent provision as the economy slowed, while core earning growth remained strong. Credit costs nearly doubled to 1.4% from 0.78% in 2017. We retain our HKD 5.50 fair value estimate. The stock is trading at a 18% discount to our fair value estimate and 0.7 times 2019 price/book, assuming a 11% growth in book value per share. The bank is undervalued because its solid deposit base and strong growth momentum should reward it a better-than-peer valuation in our view.

We believe the market is disappointed over PSBC's slowing net profit growth in 2018 and overly concerned about the rise in retail loan bad debts. We believe the bank’s fundamentals remain largely intact and credit quality risks are manageable. However, the retail bad debt ratios climbed 15 basis points to 1.07% in 2018 and corporate bad debt ratios remained low at 0.78%. Low-risk home mortgage loans accounted for over 61% of retail loans. Besides, both PSBC’s overdue loan and special-mentioned loan ratio stayed at the low end of the industry at 0.99% and 0.63%, respectively. We believe the rise in retail bad debts will be gradual and mild because of extensive diversification and the low average loan amount per customer of its retail loan portfolio. Its industry-leading provision level is at 345% of bad debts, which also supports steady growth in net profits over the near term.

The 16% revenue growth was slightly lower than our expectation because of declines in investment returns during the fourth quarter. Despite the earnings miss, core revenue growth including net interest income and fee income remained strong at 24% and 13% respectively, at the high end of the industry. Core earning growth, as measured by pre-provision operating profits, or PPOP, expanded further to 40%, from 30% in 2017, far above the industry average of below 10% according to our estimate. This indicates PSBC’s strong top-line growth and improvement in operating efficiency, which also underpinned our long-term favorable outlook for PSBC. Cost to income improved significantly by 7 percentage points to 57.6% after enhanced a cost control system and growing scale. Return on assets has continued to improve since 2016, while return on equity declined to 12.3%, primarily on lower leverage.

The net interest margin outperformed the industry by a 27 basis point expansion to 2.67%, leading to a 24% growth in net interest income. This was attributable to PSBC’s ongoing asset restructuring toward loans and solid deposit base. The deposit base grew 7% and made up 97% of total interest-bearing liabilities. Meanwhile the average funding cost merely increased 2 basis points to 1.46%, despite intense deposit competition. The loan balance grew 18%, with loan shares increasing to 51% of interest-earning assets versus 42% in 2017. The loan to deposit ratio increased to 50% from 45% in 2017. We expect the boost from asset restructuring to continue, given that the loan to deposit ratio remained lower than industry, ranging from 80% to 90%.