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Market Commentary

US stocks end lower on worries over impact of inflation on earnings

• Worries over the impact of rising inflation on upcoming third-quarter earnings saw US stocks edge lower overnight. The Dow Jones Industrial Average shed 0.3%, to 34,378.3. The S&P 500 ticked down 0.2% to 4,350.7. The Nasdaq Composite fell 0.1% at 14,465.9.

• Short-dated Treasury yields, which reflect expectations of where interest rates will be in the future, reached their highest level since March 2020, as investors bet that inflationary pressures have pulled forward the date of the first US interest rate rise. The yield on the two-year US Treasury note on Tuesday touched 0.36%, a level not reached since days after the Federal Reserve cut borrowing costs to zero to battle the coronavirus crisis. The five-year note yield reached a high of 1.09%, its highest level since February last year. The yield on the three-year note also reached a 19-month high.

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• The move came after the price of West Texas Intermediate crude oil hit a seven-year high of more than US$82 a barrel on Monday before pulling back to settle at US$80.64 on Tuesday. Brent crude, the international oil benchmark traded slightly off Monday’s three-year high to settle at US$83.42.

• The IMF urged central banks to be “very, very vigilant” about inflation ahead of data today that may show US year-over-year consumer price rises exceeded 5% in September for the fourth consecutive month. The Federal Open Market Committee is also set to release its minutes from the September meeting. Investors will digest the minutes for any potential clues regarding the central bank’s plans to pull back easy monetary policy.

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• Europe’s Stoxx 600 benchmark was volatile on Tuesday, dropping 1.2% in early dealings to fall about 5% below its all-time high reached in mid-August, before closing the session 0.1% lower.

• In Asia, Singapore shares slipped lower amid the weaker global sentiment, following declines on Wall Street on Monday. The benchmark Straits Times Index fell 0.1% to close at 3,112.05. The losses tracked major regional markets in Asia, with Australia, Japan and Hong Kong falling between 0.3% and 1.4% on Tuesday.

• China’s CSI 300 fell 1.1%, with the stocks of utilities dropping the most amid an electricity shortage driven by a lack of adequate coal supplies. Concerns are mounting about contagion among indebted developers, with Sinic Holdings Group Co becoming the latest real-estate firm to warn of imminent default.

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• After a bumpy September, stocks had recovered somewhat in October, but the rebound appears to have stalled in recent days.

• Despite near-term risks, the medium-term outlook remains favourable for now. This is supported by the ongoing global recovery from the pandemic and still-dovish central banks which are tolerating above-target inflation rates and keeping monetary policy accommodative.

• Intermittent market pullbacks can offer buying opportunities for those with a good risk appetite, although investors need to tread carefully and buy selectively.

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Agricultural Bank of China (1288 HK / 601288 CH ) Mixed results

• Pressure on net interest margin
• Relatively high exposure to developers’ loan
• Lower fair value estimate

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Pressure on net interest margin

Recent quarterly result highlighted some key concerns about net interest margin, fee income growth and deposit growth. Net interest margin (NIM) contracted 7bps q/q in 2Q21due to a combination of lower loan yield and higher deposit cost. Fee income growth was subdued and decelerated from +12.2% y/y in 1Q21 to +3.5% y/y in 2Q21. The sharp deceleration was likely due to weakness in custodian fees, which offset the strength in e-banking and investment banking advisory fee. Deposit growth was flat and only edged up +0.4% q/q in 2Q21.

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Asset quality concerns remain with higher property developer loans exposure

ABC is well provisioned, and its non-performing loans (NPL) ratio dropped 3bps q/q to 1.5% in 2Q21. But, it has the highest exposure to property developers’ loans (at around 5.2% of total loans) as of 1H21 among the Big-5 state-owned banks, making it could be more vulnerable to potential asset quality deterioration in case of a default. Common Equity Tier 1 (CET1) and total capital adequacy (CAR) ratios edged down 13bps and 14 bps q/q to 10.9% and 16.2% in 2Q21 respectively.

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Lower fair value estimate

ABC’s exposure to the property sector would be a risk to monitor, especially given the heightened liquidity issue at debt-ridden property developers. Having said that, ABC has the highest NPL coverage ratio among the Big-4 state-owned banks, offering an earnings buffer and to smooth earnings growth if needed. While NIM showed signs of stabilization at the latest quarterly results, we believe NIM could be under pressure as economic growth softens and policymakers are likely to maintain a relatively lower loan pricing and could fine-tune policy to support growth. We lower our Fair Value estimate to HK$3.3 (1288 HK) / CNY3.4 (601288 CH) by applying a lower valuation multiple of 0.45x (1288 HK) / 0.55x (601288 CH) forward Price-to-Book, which is at -1 s.d. to historical average owing to the concerns we highlighted. We view sector re-rating catalysts are limited and expect valuation to stay range bound. Within Chinese banks, we prefer those with strong retail franchise and network.

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ESG updates

Leading financial inclusion products, but lagging product review and ethical compliance practices – ABC still outperform peers in providing access to finance to underserved markets: retail loans targeting poverty alleviation and ‘Sannong’ (agriculture, rural areas, and farmers) innovation amounted to USD355bn in FY 2020 (+17.6% y/y). The bank has also provided a series of thematic loans to SMEs during the pandemic to help them resume production. However, it appears to lag peers in China in strategies and programs to protect consumer interests and in governance practices.

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ABC appears to lag peers in adopting compliance measures to mitigate corruption-related risks. It is noted the bank faced penalties of USD7.8mn in Aug 2020 over 24 alleged financial business malpractices; and an ongoing discipline inspection against a former branch vice president.

ABC has a large balance of green credit investment (around USD236bn by 2020) guided by a 4-year plan and China’s carbon neutral targets. Yet, it appears to trail leading peers in adopting specified system to manage potential ESG risks in financing activities. BUY. (Research Team)