Would you? The reasons not to buy China’s banks are many, from questionable loan quality and untested links with shadow banking to tightening liquidity. Now earnings are expected to grow less than a tenth. But there is an argument for taking another look: the negativity has made them look undervalued.
China’s banks are trading at a weighted average price of just 0.9 times their expected 2014 book value, according to CIMB, versus a long-term average of 1.8 times. Most other bank sectors in the region are at or just below their mean. Across the region historically, price/book ratios of one equate to a return on equity of 10 per cent and levels nearer two with an ROE of 20 per cent. Yet China’s big four – Industrial and Commercial Bank of China, Bank of China, Agricultural Bank of China and China Construction Bank – all offer ROEs of 20 per cent or more. That suggests their valuations discount a lot of bad news.
What might change investor perceptions? Valuations have been slipping since before the crisis. ICBC’s brush last week with bailing out a dud investment product offered through its network (it did not) will have bolstered sector bears. China’s slipping GDP growth, at 7.7 per cent at the end of 2013, from 7.8 per cent in the third quarter, will not have helped. But an alternative reading of those two points is that Beijing is serious enough about strengthening its financial system to push investors to reprice risk and will accept slower growth and weaker bank earnings growth to enact reforms, including stock market flotations and liberalising interest rates. Short-term pain for the banks but long-term gain.