Aggressive growth continues despite capital shortage; maintaining Hold
Huarong reported 1H17 results with net profit of Rmb13.4bn, up 20% yoy (57%hoh), driven by a rapid asset expansion (up 17% hoh or 55% yoy). Pre-provisionoperating profit grew by 56% yoy, offset by higher impairment losses given alow base in 1H16. Despite a weak capital position (13.9% CAR vs. 12.5%required), Huarong continued to expand shadow banking lending aggressively(up 109% yoy) and lifted company-level leverage further to 10.1x in 1H17 (vs.9.1x in 2016 and 5.9x for Cinda). The stock is trading at an undemandingvaluation of 0.8x P/B vs. 17% ROE, but we maintain our Hold due to shadowbanking concerns and fundraising uncertainty.
1H17 results highlights
Restructuring business (RDA) income grew 12% yoy driven by strongbalance growth (38% yoy), dragged by declining yield (9.8% vs. 12.1% in2016). We believe Huarong may have lowered its risk appetite in 1H17. Asa comparison, Cinda’s RDA yield dropped to 9.1% in 2H16. RDA impairedratio in Huarong was down to 1.87% vs.1.98% in 2016.
Traditional NPL disposal (TDA) income grew 63% yoy, primarily driven byrecovery in return on disposal, although disposal volume dropped 40% yoyin 1H17. TDA’s IRR improved to 19.2% from 16.2% in 1H16.
Debt-to-equity swap (DES) income rose strongly by 239% yoy from a lowbase, with an exit multiple of 5.1x (2.7x in 2016).
Huarong continued to grow shadow banking exposure and we calculatethat its non-standardized credit assets (NSCAs) reached Rmb471bn in1H17, up 26% hoh or 109% yoy, accounting for 28% total assets.These NSCAs are likely to be subject to tighter regulations during thefinancial deleveraging campaign, in our view.
By segment, Distressed Asset Management (DAM) recorded strong PBTgrowth of 50% yoy, followed by Asset Management & Investment (56%yoy), while Financial Services recorded muted profit growth (1% yoy).
Company-level total CAR rose modestly to 13.9% from 12.9% in 2016 withRmb10bn tier-2 bond issuance, but still looked weak compared with the12.5% regulatory floor. Huarong announced a Rmb20bn-equivalentoffshore preferred share plan in June; it targets A-share listing in 2018.
Valuation and risks
We adopt sum-of-the-parts (SoTP) valuation methodology, given the differentbusiness models and risk profiles of Huarong’s business lines. Key upside risk:faster-than-expected fundraising. Key downside risk: tighter regulations.