BOC Hong Kong Earnings: Better Than Expected, but We Cut Valuation Modestly as Mainland Rates Fall

Interim results from Bank of China Hong Kong, or BOCHK 02388, were better than we expected. The earnings upside was attributable to loans growing 4.3% from year-end 2022 versus a 0.6% decline for the Hong Kong banking market as a whole, resulting in a 73-basis-point increase in BOCHK’s market share to 15.84%. Also, better-than-expected expense control brought the cost/income ratio to only 25.5%. Net interest margin dipped 3 basis points from the second half of 2022 and was up 43 basis points year on year, perhaps slightly short of the overall Hong Kong market trend for the first half of 2023 but BOCHK’s net interest income still outperformed peers given its increase in loan market share. Fee income was unsurprising, rebounding 12.5% from the second half of 2022, and annualized credit costs remained low at 14 basis points of loans. BOCHK’s capital levels also continue to be extremely strong, with the common equity Tier 1 ratio rising to 19.0%.

Nevertheless, we reduce our fair value estimate to HKD 35.50 from HKD 37. This reflects a lower assumption for future net interest margins as we anticipate recent reductions in interest rates in mainland China to affect interest rates in Hong Kong. With BOCHK shares having declined 19% year to date, our new fair value estimate is in 5-star territory and represents 64% upside from the current price. It is equivalent to 1.2 times forecast 2023 book value and implies a fair price/earnings ratio of 10.4 times assuming midcycle ROE of 11.5% and a fair dividend yield of 4.8% assuming 50% payout ratio. We think BOCHK shares look quite attractive at current prices given its superb cost efficiency and our expectation that its credit costs will remain low. BOCHK’s lending in the mainland is very limited as this is mostly done instead by parent Bank of China, while its lending in Hong Kong tends to be lower-risk than the market average. Its very strong capital position also adds comfort about the future dividend outlook.