Growth could slow down on near-term capital concern; Hold with HK$3.5 TP
We initiate coverage of Huarong with a Hold rating and target price of HK$3.5（0.93x 2017E P/B）， as we believe the company is likely to slow down itsaggressive balance sheet expansion after reaching its capital ceiling in 2016.
　　We expect ROE to trend down amid a capital-raising cycle and growth couldresume after the anticipated A-share IPO in 2018. We are also concerned aboutits lower DAM return after market share expansion and large shadow bankingcredit. Nevertheless, Huarong has built up a large provision buffer and thestock still offers a 6% dividend yield, which should provide support for theshare price. The stock now trades at 0.9x 2017E P/B.
　　Time to take a break
　　The total assets of Huarong posted an impressive 46% CAGR during 2012-2016 （63% yoy in 2016）， with aggressive expansion in distressed assetsmanagement and shadow credit investment. Huarong exceeded Cinda in bothTDA and RDA volume in 2016, but with a lower return. Non-standardizedcredit grew 142% yoy in 2016 to make up 27% of assets in Huarong （vs. 6%for Cinda）。 In addition, it rapidly expanded its HK subsidiary, which nowaccounts for 10% of group assets. As a result, Huarong’s capital ratio droppedto 12.86% at end-2016, very close to the regulatory red line of 12.5%. Weexpect Huarong to slow down balance sheet expansion, with asset growthdown to 3% in 2017E before resuming to 16% in 2018E-19E.
　　Large provision buffers against balance sheet risks
Huarong has built a large provision in the RDA business （8.8% gross coveragevs. 3.7% for Cinda）， and this allows room to reduce credit cost when preprovisionearnings are behind expectation. We estimate that 100bps lowercredit cost in RDA business will likely boost Huarong’s earnings by 8.5% in2017E. It also set aside 2.2% provision coverage on shadow credit exposure.
　　Earnings forecast; valuation and risks
　　We project that Huarong’s profit growth will likely slow down in 2017E to12%, and trend up to 16%/18% in 2018E/19E post capital raising. We valueHuarong by using a sum-of-the-parts （SOTP） valuation and our target priceequals 0.93x 2017E P/B. Key upside risks: faster-than-expected capital raisingand inclusion in the SH-HK Stock Connect list. Key downside risks: delay incapital raising plans, materialization of balance sheet risk, and a worseningtrend for the bank subsidiary, leading to capital injection。