1H17 profit growth driven by investment income and distressedassets while partially offset by higher interest expense
More sustainable growth through slower balance sheetexpansion and lower risk appetite towards RDA
Retain Buy rating with target price lifted 6%, to HKD3.70 fromHKD3.50; 2018-19e earnings estimates raised by 0-1%
1H17 profit growth was 20% y-o-y, slowing from 35% in 2016. Total revenue rose51% y-o-y in 1H17, mainly driven by a more than doubling of its investment incomeand 34% from its TDA, RDA and DES businesses combined. The strong revenuegrowth was then partially offset by a 57% y-o-y rise of interest expense.
What we liked: (i) Income from TDA (NPLs acquisition and disposal from financialinstitutions) rose by 34% y-o-y. The average turnover period of its TDA disposed roseto about 5 months from 2 months in 2016 and IRR rebounded to 19.2% from 15.9%last year, indicating that the company now focuses more on margin than volume afterthe accelerating expansion in 2016. (ii) RDA portfolio grew by 13% h-o-h toRMB333bn, about 22% of total assets. Despite rising balance, the company mayhave lowered its risk appetite in this business as reflected by lower annualized returnof 9.8% in 1H17 vs. 12.1% in 2016. Impaired RDA ratio slightly declined by 6bp h-o-hto 1.75% as of 1H17. (iii) Total asset expansion slowed to 17% h-o-h in 1H17 from32% and 24% in 2H16 and 1H16 respectively; we think slower asset expansion andlower risk appetite is a more sustainable way to grow.
What we disliked: (i) The calculated funding cost in 1H17 was 4.02%, up 18bps h-o-hdue to increase of bank borrowings and bonds issued amid tightening liquidity. Incontrast, the calculated asset yield moved in the opposite direction, declining by 31bph-o-h to 4.36% in 1H17.
Other points of interest: (i) Total NPLs acquired from financial institutions declined43% y-o-y to RMB45bn, with those from large banks growing 18% while those fromjoint-stock banks and non-bank FIs dropped by 72% and 99% respectively. (ii) Totalinvestment other than distressed assets rose to RMB605bn as of 1H17, up 24% h-o-hand slowing from 62% h-o-h recorded in 2H16. (iii) Capital ratio rebounded by 103bph-o-h to 13.9% as of 1H17. (iv) The lock-up of 7.4bn H-shares held by strategicinvestors will expire on 29 Aug, which account for c30% of total H-shares.
Maintain Buy on Huarong, with target price increased by 6% to HKD3.7 as 1) we finetune2018-19e earnings by 0-1% on higher investment income which is largely offset byhigher interest expense; 2) RMB/HKD exchange rate is changed to 1.13 for 2017e from1.08 previously. Our TP implies 13% upside; we rate the stock Buy due to thecompany’s focus on distressed asset business and reduced risk appetite towards RDA.