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Morningstar | PSBC’s 3Q Net Profit Growth Hampered by Rising Credit Costs and Lower Investment Return

No-moat Postal Savings Bank of China’s, or PSBC’s, third-quarter results were a bit disappointing, with growth in total revenue and net profits slowing down to 22% and 15.4% from the year-ago period, versus the 25% and 22% growth in the first half. The slower-than-expected growth was attributable to a sharp decline in investment return and higher-than-expected increase in credit costs over the past quarter. We slightly reduced our full-year revenue growth and net profit growth to reflect recent performance, but the decline in our fair value estimate was largely offset by time value of money since our last update. Thus we retained our HKD 5.50 fair value estimate and expect full-year net profit growth to be around 18% versus the 22% prior forecast.

Despite the negatives, core revenue growth including fee income and net interest income remained strong at the high end of the industry, and the bank continued to achieve the strongest improvement in operating efficiency, as evidenced by a 556 basis point decline in cost/income ratio at 55.3%. The stock is trading at a 14% discount to our fair value estimate and 0.8 times 2018 price/book, assuming 11% growth in book value per share. We believe the bank is undervalued as its strong growth momentum deserves a better-than-peer valuation in our view. Though we’re a bit disappointed to see signs of weakening credit quality due to stricter regulatory requirements and rising macroeconomic uncertainty, we acknowledge that PSBC’s credit quality remains stronger than peers. The results confirmed our long-term thesis that PSBC will continue to stand out, thanks to its strong deposit base and low loan/deposit ratio; these support faster-than-peer loan growth and net interest margin, or NIM, expansion, which were also evident in its past results. The fast-growing scale also translates to continuous improvement in operating efficiency.

Net interest income grew 27%, largely flat from the first half. This was driven by a 13 basis point increase in NIM. Leveraging the central bank’s liquidity injection, PSBC increased the proportion of loans and bond investment by 4.2 and 3.4 percentage points, respectively, and reduced shares of deposit reserve at central banks and interbank investment by 2.3 and 4.5 percentage points, respectively. This more than offset the rise in deposit costs. Looking forward, we expect rising deposit cost will outweigh the increase in asset yield as marginal impact of the central bank’s liquidity boost will mitigate. Thus Chinese banks will face rising challenges in NIM in coming quarters.

Credit quality remained better than peers, though bad debt ratio picked up to 0.88% from 0.82% in mid-2018. Bad debt balance, after adding back accumulated write-offs, grew 2% from the previous quarter, versus the 30% increase in the second quarter when PSBC started to adopt a stricter bad debt classification. Bad debt formation ratio was 1.08%, higher than the 0.62% in the year-ago period partially due to stricter classification standards. Management noted overdue loans balance and special mentioned loan balance dropped 2% and 7% from mid-2018. With both ratios standing at 0.96% and 0.58%, much lower than industry peers, we believe PSBC’s provision pressure will remain lower than peers.