【Sector Research】China Brokerage Sector – Structural changes occurring; valuation attractive to play beta

We’ve seen gradual structural changes to China brokers revenue mix in FY20, where IB and AM, two business lines we believe brokers’ long-term competitiveness thrives from, achieved faster growth, thanks to progress in capital market reforms and transformation of WM and AM. After two years of profitability improvement, China brokers still trades at 2-year low. We see limited downside here and brokers are good proxy to capture potential market sentiment recovery as long as liquidity is not getting too tight. We maintain OUTPERFORM rating on the sector and our top picks CITICS (6030 HK) and CICC (3908 HK).

  

  1. FY20 results recap: Fee growth outpacing capital-based income; leaders gaining shares. Our covered brokers reported 32% YoY aggregate op. revenue growth, where fee incomes (brokerage+IB+AM) saw higher growth (+47% YoY) and % in total op. rev. picked up 5ppt YoY to 50%. We see this change stemming from 1) accelerated WM transformation and growing asset allocation demand to stocks, 2) implementation of registration-based IPO system that boosted equity financing demands; and 3) mutual fund issuance boom that spurred fund mgmt. AUM. Besides, market consolidation trend was clear across business lines. We see emerging equity financing demand after rapid leverage-up, e.g. CSC, while CITICS already announced plan.

 

  1. 1H21E outlook: Fees and NII to grow on low base; prop-trading a key swing factor. 2021 YTD market activity remained robust despite volatility in stock market. We expect leaders to continue share gain in brokerage and AM amid ongoing institutionalization, while IB will exhibit divergence as recent tightening IPO rules may slow some brokers’ income; the implementation of registration-based IPO system to the whole market is not likely in near term. Brokers with strong oversea IB franchise tend to perform better in 1H21E, in our view. NII is also likely to YoY increase on higher avg. balance. Regarding prop-trading, those gained from stock market rally last year, are faced with potential lower investment yield in FY21E.

  

  1. Current valuation attractive to welcome sentiment recovery. Maintain OUTPERFORM. Despite consecutive ROE recovery since 2018, China brokers are still trading undemandingly at 0.7x forward P/B, or at three-year average minus 1SD. The sector is also lagging behind other China H-share financials, down 2% on avg. YTD, vs. China banks +14%/China insurers +2%. We think current market activity is still healthy and any recovery of sentiment could potentially boost brokers’ share price performance. Top picks are CICC (3908 HK) and CITICS (6030 HK). Key risks: 1) tighter-than-expected liquidity; 2) slower-than-expected capital market reforms; 3) stock market plummet.
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