China AMCs:Riding on deleveraging cycle

Benefiting from deleveraging cycle; prefer Cinda (Buy) over Huarong (Hold)

    We hold a positive view on the China AMC sector, with China Cinda ourpreferred play. We initiate on China Huarong with a Hold rating. We expect astrong supply pipeline of distressed assets amid the corporate deleveragingcycle to benefit these largest distressed asset managers in China. Per ourprojections, profit growth for these two AMCs is forecast at a 17% CAGR over2016-19E. Near term, the tightening environment may trigger refinancingdifficulties for corporates, leading to rising liquidity bridging business forAMCs. We expect a re-rating on Cinda, given its stronger capital position andfavourable ROE trend (18% return on tangible book) with a 6% dividend yield.Deleveraging and recent tightening to drive earnings upside for AMCs

    We believe it is still too early to call an end of the credit cycle and we expectdistressed asset supply in China to continue to grow in the high teens, drivenby rising shadow banking NPLs and distressed corporate A/Rs. The recentfinancial deleveraging and tightening, in our view, will particularly benefit therestructuring and mezzanine financing businesses. Our sensitivity shows that a5% higher average RDA balance and a 50bps higher yield together wouldboost recurrent profit by 6-7% for Cinda and Huarong in 2017E.AMC business outlook: focusing on RDA, investment and overseas

    Restructuring, or the RDA business, is a key profit driver with 10%+ yieldwhich contributed 20% of AMCs’ PBT. The recent tightening environmentshould boost both RDA volumes and yield. AMCs have a growing investmentbook in mezzanine funds and shadow credit, and we expect the latter to slowdown due to regulations. Meantime, AMCs may continue to expand theoverseas arm in the near term, funded by offshore bond issuance. Fortraditional NPL disposal, we expect rising competition with more local AMCsentering the space. On debt-to-equity swap, AMCs will still focus on the exit ofhistorical book instead of following banks to expand DES.Cinda vs. Huarong: divergent ROE trend

    We have a Buy recommendation on Cinda and believe it will benefit from 1)more RDA demand from the property sector, 2) DES value appreciation fromelevated coal prices, and 3) faster growth of newly-acquired bank subsidiary(NCB). In contrast, Huarong has a much weaker capital position (CAR: 12.9%vs. 19.4% for Cinda) and a large shadow banking exposure (27% of assets vs.6% for Cinda). We expect Huarong to slow down growth in the near term andsee an ROE down trend in the capital raising cycle.Valuation and risks

    We adopt a sum-of-the-parts (SoTP) valuation methodology for Cinda andHuarong given the different business models and risk profiles of business lines.For Cinda, we cut our target price by 19% to reflect a higher risk-free rate andpremium paid for NCB. Our target price for Cinda/Huarong equals to0.92x/0.93x P/B. Key sector risks include a large drop in property prices, risingbalance sheet risks related to investment, and weaker-than-expecteddistressed asset supply. This report makes the transfer of stock coverage onChina Cinda to Jacky Zuo from Hans Fan.