We initiate coverage of China Securities with a view
that valuation has gotten ahead of growth outlook.
As we prefer less complex, capital-light models, we
initiate Galaxy at EW, Haitong at UW, and assume
coverage of CITICS at UW, noting CITICS’ premium
valuation and ROE pressure.
Average valuation factors in overly optimistic
outlook for new businesses. As quasi-lending has
become a key new revenue source, we think the stricter
regulatory framework for China securities firms puts
them at a competitive disadvantage vs. alternative
lending channels. This, combined with only modest
revenue benefit likely from the planned launch of mutual
market access between SH/HK markets, will likely keep
sector ROE at around 8.5%, which makes the average
sector valuation of 1.5x 2014e P/B a bit rich, in our view.
Structural opportunities hinge on evidence of real
progress in China’s reforms, which may take some
time. The resurgence of government influence on
economic growth has reduced economic development
efficiency and weighed on equity market development,
in our view. As the equity business will likely remain the
key revenue driver, we believe evidence of meaningful
progress on reforms will be needed to drive structural
opportunities for A-shares and China securities firms.
Our earnings forecasts reflect our expectation that a
modest rebound in the A-share market from current low
valuation levels will drive modest growth in A-share
turnover and equity issuance volume.
Good high-beta investment at the right valuation,
given low balance sheet risk and benefits from A-share
rebounds or China reforms. Our target P/B for China
securities firms is 1.1x-1.3x, based on P/B vs. mid-cycle
ROE. We believe China securities names that trade well
below the P/B implied by mid-cycle ROE during troughs
in A-share turnover will offer good returns.