China: New Focus for Yield Lovers
Timothy Fung, Head of Equity Advisory, Asia
Traditionally yield-seeking investors have been investing in China banking stocks for their stable yield. However, given the significant deterioration in the macro backdrop and banking industry landscape over the past year, what could yield-lovers possibly focus on now?
China Banks are Not Due for a Fundamental Recovery … Yet
As we stepped into October 2020, Chinese banks enjoyed a nice rally from its multi-year low, partially driven by sector rotation into this consensual underweighted and less favourable sector. At the same time, the People’s Bank of China (PBOC) made an announcement on a provisional draft of the revised Commercial Bank Law seeking public opinion. Compared to the current version (updated in 2015), the new draft revises the law in eight key aspects (Diagram 1).
Indeed, most of the content in the new version has already been implemented through various regulations in recent years, although the legislation of the revised law will solidify its legal status. Perhaps the most relevant topic to investors would be Article 62, as this may affect banks’ profitability. Although Article 62 in the draft states that banks are prohibited from engaging in trust investment and brokerages, we believe that draft hints at the potential to allow banks to expand their business scope in these categories.
DIAGRAM 1: KEY ASEPCTS OF THE REVISED DRAFT OF CHINA'S COMMERCIAL BANK LAW
Source: The PBOC as of October 2020
Continue to Sell Chinese Banks on Rebound
Trading at historical low forward price to book value (P/BV) (at 0.6x currently for most H-share banks) (Diagram 2), value investors have been anticipating earning catalysts to add weight in the sector. We see the new law as a good long-term development for the stability of China’s financial system. However, structural headwinds such as interest rate deregulation and national service risk remain intact, therefore we maintain our cautious view on Chinese banks and continue to suggest investors to sell-on-rebound. Yield lovers, who are disappointed by Chinese banks’ performance, could also consider switching into Hong Kong utility stocks as a good alternatives.
DIAGRAM 2: CHINA H-SHARE BANKS AVERAGE ONE-YEAR FORWARD P/BV
Source: Bloomberg, as of 28 October 2020 The above chart is for reference only and does not represent current or future performance.
Appealing Risk-reward on Hong Kong Utility Stocks
Apart from Chinese banks, their global counterparts also faced increasing global macro headwind. Many large global banking groups have loosened their faith in “promising dividend yield” – not just because of COVID-induced short-term earnings impact, but also due to structural headwinds like internet banking, one-way direction of interest rate, more restrictive policies post crisis, regional politics, etc. From an equity portfolio management perspective, the role of banks as a defensive cycle has been fading, especially for the conservative pension funds. This role needs to be filled.
After meaningful year-to-date (YTD) share price corrections, some Hong Kong listed utility companies are now trading at a more reasonable risk-reward. Hong Kong utility companies’ share have generated a divergent performance of +7.2% to -29.8% YTD. Although some of them still underperformed Hang Seng Index’s (HSI)’ -9.9%*, we still believe that this offers a good reason for yield-seekers to reconsider these defensive stocks.
The sector is now trading at 4.9% 2021E dividend yield (Diagram 3) , implying a 410 basis points (bp) spreads versus the 10-year US Treasury (UST) yield, which is a historical high. Compared to banks, utility companies also offer much higher visibility in their earnings, cashflow and more importantly, dividend payment.
DIAGRAM 3: DIVIDEND YIELD OF MSCI HONG KONG UTILITIES INDEX VS. 10-YEAR UST YIELD
Sources: Bloomberg, as of 4 November 2020 The above chart is for reference only and does not represent current or future performance.
Hong Kong Property Market is Close to Tipping Point
Apart from utility companies, bottom-fishers have also started to look at the property sector within the Hong Kong market. Recent strong demand in the primary market has proven that some investors may now be of the view that the uncertainties brought about by the pandemic and US-China tensions will gradually ease.
For retail landlords, occupancy at popular shopping malls in Tsim Sha Tsui and Causeway Bay appears to be stable from June 2020 onwards. Government officials have warned of a possible fourth wave of COVID-19 infections in the coming winter, which may kill the current green shoot easily. On the office front, we have yet seen corporate capex resumption due to the continued lockdown of developed countries.
Accordingly, we continue to prefer residential developers to landlords, as we expect the downward rental reversion in both retail and office segments to last until mid-2021, before any clear development on the vaccine front.
Select Hong Kong developers with visible sales pipeline, abundant net cash and strong balance sheet are expected to resume their generous dividend payment policy once the pandemic is over.