First off – I do want to say that I might not be right about this.
Buying China banks now is like buying Citibank or AIG in 2008.
You’re either going to look like Warren Buffet in 5 years, or you’re going to lose everything.
But then I figured – What’s the riskier move now:
- Buying China banks at 0.35x book value and a 7.5% yield, or
- US Growth stocks at 100 times Price/Sales into a Fed hiking cycle?
Whatever the case, I’ll share my thought process below, and I would love to hear from you.
Whether you think I’m nuts, or I’m missing something – Just let me know!
Basics: China Dividend Stocks – Too Cheap to Ignore?
If you haven’t looked at the China Dividend Stocks for a while, you’ll be amazed at the valuations.
The 4 big banks – ICBC, CCB, ABC, Bank of China, all down about 20%+ from highs.
Here is ICBC, the largest bank in the world.
Trading at 7.5% dividend yield, and 60%+ discount to book value.
Ping An, the largest insurer in China – down 50% from highs, at a 4.84% yield.
Which is higher than some blue-chip REITs in Singapore. Don’t forget there’s no dividend withholding tax between HK and Singapore, so that full dividend goes into your pocket (there is 10% between PRC and HK though, so you pay 10% withholding tax all in).
The China oil companies – Petrochina, Sinopec, CNOOC, down about 40% from highs, and trading at 6.68% yield (CNOOC).
Look at how CNOOC is down 40% from pre-COVID, and compare that to Exxon where prices have recovered to pre-COVID.
I know that there is a lot of China risk, but as investors the question is at what point do we take this policy risk to be priced in?
What do earnings look like – ICBC
For the record, this is what ICBC’s earnings look like.
Net profit is up 10.5% year on year, EPS up 4.55%.
60%+ discount to book, and a 7.5% dividend.
But really, that’s missing the point to me. The elephant in the room is China’s real estate crisis, and China policy risk.
China’s Lehman Moment is playing out fast
We talked about Evergrande （恒大）being China’s Lehman moment. If you haven’t seen it yet, go read it as it provides important context.
Long story short – Things are getting hairy for China real estate, real fast. With echoes of 2008.
Real estate is 40% of China’s economy, and possibly more for a China bank’s loan book.
To understand if China banks are a good investment, we need to understand how the real estate cycle is going to play out.
As a Property Developer, there are 3 ways to raise money, all of which have been hit very badly:
- Sell Properties
- Borrow from a bank
- Borrow from Capital Markets
Property Transaction Volume in China is down 30 – 40% year on year.
Home prices have fallen 30-40% in a year in some cities.
Homebuyers are frightened that if they buy a new property now, they may never get it because the developer goes bankrupt.
No property sales, means no cash flow for property developers.
Sure, you can sell your EV business like Evergrande, but when there’s blood in the water everyone smells it. You’re never going to get anywhere near fair market value for your assets.
Borrow from a Bank
The three red lines set out guidelines on how much debt a property developer can borrow.
Most of the most indebted developers (like Evergrande) violate the three red lines, so they can’t take on additional loans from banks.
Borrow from Capital Markets
China high yield dollar bonds are trading at 20%+ now, which is getting close to 2008 levels.
China property developers are effectively frozen out of capital markets.
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Contagion is spreading fast
The past week saw China developer Kaisa Group Holdings default on its wealth management products, and call for trading halt in HK.
Here’s the share price performance of the other China developers:
Government land auctions are also in trouble, with 27% of land parcels failing to attract buyers, and land premiums falling across the board.
Land sales are a big driver of local government income, so this will have broader knock-on effects (reducing local government spending).
In my view – there’s only one way out of this, and that’s for the CCP to step in.
Has the CCP Blinked?
It wasn’t very clear how, but this week Evergrande made payment and avoided defaulting on their bonds.
The WSJ also reports that CCP is looking to ease some of the restrictions on property developers.
Long story short – if you buy properties from another indebted developer (eg. Evergrande), the leverage taken on wouldn’t count towards your own three red lines.
This is a big move – sparked a huge rally in China real estate shares on Thursday.
If you were looking for a sign that the CCP has blinked, this might just be it.
Will this be enough?
I can’t help but feel that this isn’t enough though.
This is playing out like a classic real estate cycle.
Prices come down, people stop buying, developers have no cash flow, they are forced to fire sell, in a vicious cycle.
It’s a crisis of confidence now, and a small tweak like that may not be enough.
No official word out of Beijing, nor has the PBOC done any liquidity injections.
So even though a bailout will probably come eventually, for now Xi is happy to sit on his hands and watch everyone sweat.
Real Estate speculation is dead
Even if they do step in, my sensing is that Beijing is serious about stamping out speculation in housing. Which means that real estate growth will stay slow for a while.
From Caixin (emphasis mine):
In a Sept. 29 report, Tianfeng Securities expects real estate sales and financing to get some relief in the fourth quarter. But most experts say the thrust of Beijing’s “houses are for living” policy will not change in the long run, and it is difficult to reverse the sector’s long-term cooling.
Multiple people close to the sector told Caixin that there will not be a fundamental shift in real estate financing policy. China’s tightened management mechanism for real estate lending will stay in place as part of normalized policy, the central bank said last month in its 2021 financial stability report.
The central government has insisted that property not be used as a short-term stimulus for the economy, said Zou Lan, head of the financial market department at the People’s Bank of China at a news briefing on Oct. 15. The central bank asked lenders to keep credit to the real estate sector “stable and orderly,” he said.
What are the risks with China banks?
Where do I even start.
First off – the book value is a complete black box.
Go pour over the financials of ICBC – you’ll have absolutely no clue what’s on the loan book.
The asset base is $5 trillion, but if they actually call on those loans, what percentage of that can be repaid?
Secondly – China risk.
If things start blowing up, the China banks are going to be asked to step in in the name of national security.
They’ll be asked to extend loans to indebted property developers to stave off contagion, and they’ll be asked not to call on existing loans. They may even be required to buy out certain toxic assets.
And of course – real estate risk.
We talked about this above, so I won’t belabour the point. Short term, it looks like a lot of these real estate loans may go bad.
Is there implicit state guarantee?
When I was in China a few years back, I remember talking to a local fund manager.
He told me not to overcomplicate matters – and just buy the China banks / insurers / securities companies.
He acknowledged that the book value was a giant black hole, and that nobody knows their true worth.
But in his view, as long as you’re investing in one of the SOEs (like Ping An and ICBC etc), the China government would never allow them to default.
In his view, you could buy them, and collect the fat dividend year after year without fear that it would be cut. And just ignore the short term fluctuations in price.
At today’s prices, that fat dividend is 7.5%. As long as you can sell the banks at breakeven in 6 years, you’re already up 50% from dividend alone.
Look at the bigger picture
The problem is that the real estate crackdown is not an isolated incident.
It’s happening at the same time as a crackdown on China Tech, on data security etc.
All happening while China is trying to maintain zero COVID in the face of the more contagious Delta variant.
And quash domestic unrest.
That’s a lot of balls to juggle, even for the all-powerful Xi.
Buying China Banks require a leap of faith
You need to ask yourself if you believe in the China growth story, over a 10 – 20 year timeframe.
Do you believe that by 2050, China will be a global superpower, and the entire Asia-Pacific region will be dominated by China just like how America dominates the west?
If your answer is yes, I would say buy some of these SOEs, forget about them for the next few years, and just keep buying on dips. And you’ll probably make off like a bandit.
If your answer is no, then avoid China completely. The short term is very uncertain, and there are many potential paths this can take. Many of which will not end up well.
My Personal View? Are China Banks a good buy?
I know it doesn’t seem like it – but I’m an optimist at heart.
Hand (hoof?) to my heart – I think China will become a superpower by middle of this century. I just don’t know the path it will take to get there.
So I will probably add to these China dividend stocks.
At a 7.5% dividend yield for the banks, I think the risk-reward here is attractive.
This isn’t some small Thai bank we’re talking about.
The 4 big China banks (ICBC, CCB, AGC, BOC) are the four largest banks in the world. ICBC has a loan book 60% bigger than JP Morgan – the biggest American bank.
Our very own Temasek has an 8% stake in ICBC, although I don’t know if that’s a good or bad sign.
Jokes aside – I think push comes to shove, Beijing will have no choice but to bail out the sector if things get hairy. Just like how America bailed out the system in 2008.
If one can sit out the short term volatility, at some point the loan growth will return as the other sectors of the economy like manufacturing and EV continue to grow.
Which only leaves pricing, and timing.
When to start buying?
And that’s where it gets tricky.
I still think things will need to get worse before they get better.
To put it in 2008 terms, I think we’re somewhere in June 2008 (Lehman was in Sep 2008).
With bond yields at 20%+, it feels like we’re getting close to point where somebody blinks. Either the CCP relents, or bigger things start to break in the economy.
I would say that in 3 – 6 months, we either have something blow up. Or the sector starts to recover.
That said – I missed the bottom for China in Feb 2020 because I underestimated the role of policy in China.
So take my timings with a pinch of salt.
For China, you want to look for the narrative shift as your cue to start buying. Unlike the West where you look at actions.
Some of you may argue that the policy tweak by the CCP this week marked the start of the narrative shift.
It’s a tricky call though – and I’ll much rather be late and miss out on some gains, than be early and buy into a 20% decline.
Watch your risk, the upside will take care of itself
FSMOne has this chart that shows the upside potential of the 4 big China banks:
To me that’s the wrong way of approaching the issue (and also wildly overoptimistic – the banks will never go back to 0.85x book value).
In investing, you always look after your downside first, and let the upside take care of itself. Not the other way around.
Risk management wise, I’ll probably want to cap exposure to China banks at no more than 5% – 10% of my portfolio in case I’m wrong and things go south.
I also want to average in in case I’m wrong, at least until Xi’s “reelection” late next year.
Full disclosure: I haven’t started buying the China banks yet (apart from the positions I hold from a few years back). But I may start soon, perhaps as early as next week.
Do note also that I may change my decision if the facts coming out of China change, and this article won’t be updated going forward. If you’re interested my latest views and buy/sell timings are available on Patreon.
What to buy? China Dividend Stocks?
The banks are interesting to me.
The 4 big ones (ICBC – 1398, CCB – 939, ABC – 1288, BOC – 3988) are all fine.
It’s like DBS v UOB v OCBC, if the Singapore economy recovers they all go up. Personally I like ICBC and China Construction Bank, but that’s more for personal reasons.
I like Ping An too, and possibly also the oil companies. CNOOC is very cheap considering oil has recoved to $80 a barrel, and it is still at COVID lows.
China real estate might be a bit too early to touch, unless it’s via one of the offshore players like CapitaLand / Link REIT / Hang Lung / CapitaLand China Trust etc. I think real estate growth will be subdued for a while.
China Tech too, but the analysis for that is slightly different from the dividend stocks, as there are other considerations in play.
You can check out my China Stock Watch for the full watchlist – I’ll be updating it this month to include the China dividend stocks.
Closing Thoughts: China Stocks uncorrelated with Western Stocks?
After last week’s piece on Best Growth Stocks, a lot of you expressed concerns about valuations and late cycle timing.
And that got me thinking – what is the one asset class that is uncorrelated with US stocks?
Like we saw in March 2020, even things like Gold and Treasuries are no-bid in a liquidity event, when all the risk parity funds sell at the same time.
China stocks are interesting because at this point, all the momentum chasers and hot money have already exited. All the hot money is in US Growth and Crypto now.
On Wednesday when US growth was selling off on inflation fears, China tech stocks were actually rallying.
So as we head into the new Fed hiking cycle, China stocks that are down 30%-50% from highs could provide a portfolio hedge?
Love to hear what you think!
As always, this article is written on 12 Nov 2021 and will not be updated going forward. Latest thoughts (and my stock watch and personal portfolio) are available on Patreon.
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