This article will present, discuss, and analyze two top Chinese companies. In my opinion, these are the top two investments that one can make right now in China. Both of these companies have U.S. traded ADRs, which makes investment in them accessible to investors in the United States. The two companies that we will take a look at today are China Mobile (NYSE:CHL) and Bank of China (OTCPK:BACHY) (OTCPK:BACHF). For purposes of this article, a case will be made for an investment into each of them based on major catalysts going forward along with healthy dividend yields. As you will notice above, there are two ticker symbols for Bank of China. This is because BACHF represents one ordinary Hong Kong share and BACHY represents 25 ordinary Hong Kong shares.
For some background information, China Mobile is the largest mobile telecommunications company by market capitalization in the world, per Wikipedia. It is well known for that reason along with the fact that it boasts an enviable subscriber base. Because of this, it was only a matter of time before it reached an agreement with Apple (NASDAQ:AAPL) to provide the iPhone to Chinese subscribers. This has finally transpired, and the benefits of this will be discussed in detail here in a bit.
Bank of China is one of the five biggest state-owned commercial banks in China, per Wikipedia as well. It operates in traditional segments as any bank would, and I believe that it stands ahead of others in China due to the fact that it has a large and expanding customer base outside of China. These diversification efforts will pay dividends down the road in my opinion, without considering the earnings growth it already is currently experiencing. Because of this growth in earnings, it is one of the most generous banks I have ever seen in terms of dividend yield. A little known fact about it is that its dividend has grown upwards of 10% each year in recent years, and we will delve into that more as this article progresses.
First, let's take a look at the dividend that China Mobile pays shareholders. Per the NASDAQ web site, we can see that China Mobile paid its shareholders $2.035 per ADR in dividends in 2014. Based on its 8/29/2014 closing share price of $62.28, this equates to a dividend yield of 3.27%. While it is not as high as the dividend yield is for other major telecom companies, on January 2, 2014, the company had a closing share price of $50.27. This is a 23.89% increase from its closing share price on the first trading day of the year, and illustrates that China Mobile is not just a steady source of dividend income, but also can be a major growth stock.
Bank of China pays a hefty dividend, and it also has been increasing its dividends in recent years substantially. When taking a look at its recent dividend payouts, we see that it paid a $.667 dividend so far in 2014, which represents a 5.764% dividend yield based on its closing share price on 8/29/2014 of $11.57. As we can see from its recent dividend payouts, over the last three years it has increased its dividend by well over 10% each year.
This has been underpinned by strong and growing earnings, with its 2014 half-year interim results producing a healthy 11% year-over-year increase. As a result, its dividend paid out in 2015 stands to enjoy another large increase since it will be based on 2014 earnings. Full-year 2013 earnings for Bank of China were about 12.3% higher than in 2012, and it raised its dividend by 13.65%. Due to the fact that earnings growth slowed down slightly so far in 2014, coupled with the increased provisions for bad loans announced with the 2014 interim results, let's be more conservative and estimate that there will be a 10% dividend increase next year.
An estimated 10% dividend increase applied to the 2014 dividend for Bank of China of $.667 per share would bring the yearly dividend to $.7337. Applying that to its current share price of $11.57, its current yield on cost would balloon to 6.341%. Currently, I believe the market is discounting this stock because of concerns over a slowing Chinese economy and its increased provisions for bad loans.
I believe that these concerns are being overstated by the market, first because as its most recent earnings release has shown, it is still experiencing strong earnings growth. Furthermore, after examining the interim results report, it becomes evident to me that it enjoys very conservative metrics compared to Chinese standards, putting it in a superb position. Increasing provisions for bad loans will shore up its balance sheet, and an uptick in the economy can lead to recovery of allowances for bad debt that would be written off. Basically, if the company is conservative in its estimates, it is limiting further downside risk and thus reducing risk in buying this stock at current levels.
Upon examining industry metrics for the quality of its loans and its liquidity ratio, one can see that it is comfortably below Chinese standards for limits in these ratios. In looking at the interim results per the company web site, these strengths become glaring.
Pages 39 and 41 of this report illustrate this strength. The regulatory standard by the Chinese government for loan concentration ratio of the top ten borrowers must be less than or equal to 50. For this metric, Bank of China's current ratio is 14.4. Its liquidity ratio for RMB, which is the biggest currency that the bank deals with, is 51.9. Regulatory standards specify that this ratio must be greater than or equal to 25. As we can see, both of these metrics imply that Bank of China has over a 100% margin of safety in meeting the required standards. This conservative approach gives it more leeway in growing revenues without regard to currencies or types of investments, in my opinion.
In taking a look at its investments in foreign bonds on page 18, we can see that it has decent sized investments in European bonds of the strongest countries in Europe. Currently, the markets there are struggling which means that investment gains can be made if and when these markets recover. I believe that this is inevitable, and it puts Bank of China in a position to capitalize on these gains when the time comes.
While these attributes bode well for Bank of China, in my opinion, there are two major catalysts that I believe will help it continue to grow income. These include its impressive credit and debit card revenue growth, along with a growing and large percentage of international deposits and loans. Jefferies noted when Bank of China released its first half 2014 earnings that this diversification in loans and deposits will make it less susceptible to RMB interest rate deregulation, which is a cause for concern with Chinese banks. The lowering of spreads for its deposits and loans could put a strain on profit growth, but Bank of China is growing its overseas business and that will mitigate this risk in my opinion.
Page 22 of the interim results report for Bank of China quantify this strength. It shows that corporate deposits from overseas grew by 22.34% as of 6/30/2014 compared to 12/31/2014. Personal deposits from overseas grew by over 7% as well. Corporate overseas loans grew by a staggering 28% over this time frame as well.
The second catalyst and strength that I noticed in this report is quantified on page 27 of the report. This discusses credit and debit cards outstanding and the related transaction amounts from these cards. The cumulative number of social security cards with financial functions grew by an impressive 16.33% margin as of 6/30/2014 when compared to 12/31/2014. Over this same time frame, the transaction amounts from debit cards grew 24.73% and transaction amounts from credit cards grew by an astounding 36.41%. Continued growth in these segments could produce a prolific affect on earnings, and with the various types of cards that Bank of China offers, this momentum is poised to continue in my opinion.
China Mobile, as indicated earlier in this article, has enjoyed a very strong 2014 in terms of share price appreciation. Some might say that this share price increase is a cause for concern going forward, as we may already have seen all of the gains that it will have for the foreseeable future. I would disagree with this notion, since on October 1, 2007 it had an adjusted closing share price of $81.24. (Per Yahoo! Finance) As this illustrates, it still has a long way to go just to reclaim its all-time high. In my opinion, it will do so, provided it maximizes its opportunities. Recent developments in its deal with Apple prove that the company is willing to do this.
It has received a lot of positive attention from its long-anticipated 2013 deal with Apple to provide its customers with the iPhone. The deal was announced in December of 2013 and it has started to gain momentum for China Mobile in 2014. In the comments from analysts that accompanied its first half 2014 earnings release, it showed that China Mobile has enjoyed faster 4G growth than what was initially forecasted. This bodes well for being able to provide the iPhone, as the latest models and the new iPhone 6 will require optimum technology from China Mobile.
In its earnings report, China Mobile grew its revenue by 29% in the second quarter of 2014 when compared to the first quarter of 2014. Earnings came in 11% ahead of the consensus estimate, which helped to propel the recent and current rally that we are seeing in its share price.
Another blockbuster announcement that accompanied this earnings report is that China Mobile will cut the subsidies that it provides for the high end mobile phones, and this will save the company $2 billion. Referenced from the earnings release link provided two paragraphs ago, 2014 subsidies will amount to 21 billion Yuan, down from the 34 billion Yuan that it initially expected to spend in 2014. With the amount that it spent in the first half of 2014 on subsidies, this leaves only 5 billion Yuan left to be spent in the second half of 2014.
There is a risk that the lowered subsidies will lead to less subscribers of phones such as the iPhone 6 by China Mobile subscribers. It will indeed lower expenses, and I believe that this is a game changing move for China Mobile. When Apple first produced its iPhone and had AT&T (NYSE:T) as its exclusive carrier, it provided AT&T an unprecedented opportunity to grow its customer base. A drawback of the deal for AT&T was that in order to obtain the exclusivity, the subsidies that it had to provide were considered high. I consider this a major factor as to why AT&T's share price has not increased much over the past 5-10 years.
As the iPhone has evolved and become more entrenched in society, coupled with the fact that it is sold through many wireless carriers, the need for a high subsidy has subsided, in my opinion. This is further magnified by China Mobile's immense negotiating power due to the fact that it boasts over 700 million wireless subscribers.
By being able to negotiate a $2 billion cut in subsidies provided for customers buying Apple and other high end smartphones, it saves the company a lot of money and eliminates some of the risk of the venture. By avoiding having to pay a high upfront cost associated with the sale of these phones, China Mobile is monetizing its subscriber base from the beginning. This proves that management is committed to maximizing the company's value and puts the company in an enviable position when it comes to generating profit from this deal.
The major risk to this, of course, is that less people will buy the iPhones because it costs more. I do not believe that will happen, particularly because the iPhone 6 and similar phones' prices are inelastic to some extent. It appeals to the high end market, and with a growing high income population in China, it still will be the phone to have. While customers will have to pay more upfront to obtain the phones, it is a cost they would have paid anyway as it would have been built into its cost over the longer term.
This provides China Mobile with added incentive and motivation to market and sell the iPhone. With 700 million subscribers and $2 billion less in costs upfront, I see that there is the potential for China Mobile to become the most profitable telecom company ever to provide smartphones. While the introduction of the iPhone through AT&T did not provide AT&T shareholders with a large increase in share price over the years, it sure did for Apple. China Mobile, in my opinion, will avoid a repeat of that and this is a major catalyst for its share price for these reasons.
In examining China Mobile's 2014 interim results, there are some other major strengths that the company has enjoyed. For the first half of 2014, the data business segment experienced 27.8% growth compared to the same time frame in 2013. The company also boasted of 13.94 million 4G subscribers as of June 30, 2014.
Revenue from data services grew to 40.9% of telecommunication revenue, which is up from 33.5% in the first half of 2013. I believe that this is sustainable growth for the company, as increased adoption of 4G phones in China will provide many more opportunities for the growth of this segment. Thwarting the decline in voice services revenue will be a key issue going forward, and if the company can meet this challenge and return it to growth as well, earnings can continue to grow at a strong clip.
Another concern for income investors is that the company reduced its dividend slightly in 2014 compared to 2013. This is entirely mitigated by the strong capital gain we have seen in 2014 however, and as long as that continues, no one is going to complain about the dividend not growing as fast as other companies.
One more area of strength for China Mobile and its shareholders is that it has an enviable amount of cash on its 6/30/2014 balance sheet. It grew by over 64% compared to 6/30/2013, and speculation has started to grow as to what the company should or will do with it. The potential for a special dividend remains, along with there being a chance that it will be used for a major acquisition, which is a move that the company has avoided thus far.
In conclusion, I recommend that investors consider investing in Bank of China and China Mobile for the reasons discussed here. With Bank of China, you have a company that is growing its earnings nicely, along with a recent track record of generous dividend increases to accompany its current dividend yield of over 5%.
With China Mobile, you have a company that is starting to heat up in the market, but I believe that its best is yet to come. It pays a healthy dividend yield, and has an amazing catalyst to improve its earnings by offering the iPhone and other high end smartphones at a bargain.
As always, please conduct your own research and due diligence before buying any stock.
Disclosure: The author is long BACHY, CHL, T.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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