What Makes Guangzhou Rural Commercial Bank Co., Ltd. (HKG:1551) A Hard Investment?

Guangzhou Rural Commercial Bank Co., Ltd.’s (HKG:1551) profitability and risk are largely affected by the underlying economic growth for the region it operates in HK given it is a small-cap stock with a market capitalisation of HK$49b. Since banks make money by reinvesting its customers’ deposits in the form of loans, strong economic growth will drive the level of savings deposits and demand for loans, directly impacting the cash flows of those banks. After the Financial Crisis in 2008, a set of reforms called Basel III was created with the purpose of strengthening regulation, risk management and supervision in the banking sector. These reforms target bank level regulation and aims to improve the banking sector’s ability to absorb shocks arising from economic stress which could expose financial institutions to vulnerabilities. Since its financial standing can unexpectedly decline in the case of an adverse macro event such as political instability, it is important to understand how prudent the bank is at managing its risk levels. High liquidity and low leverage could position Guangzhou Rural Commercial Bank favourably at the face of macro headwinds. A way to measure this risk is to look at three leverage and liquidity metrics which I will take you through today.

Check out our latest analysis for Guangzhou Rural Commercial Bank

SEHK:1551 Historical Debt December 19th 18
SEHK:1551 Historical Debt December 19th 18

Why Does 1551’s Leverage Matter?

A low level of leverage subjects a bank to less risk and enhances its ability to pay back its debtors. Leverage can be thought of as the amount of assets a bank owns relative to its shareholders’ funds. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Guangzhou Rural Commercial Bank’s leverage level of 14.78x is significantly below the appropriate ceiling of 20x. This means the bank has a sensibly high level of equity compared to the level of debt it has taken on to maintain operations which places it in a strong position to pay back its debt in unforeseen circumstances. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.

How Should We Measure 1551’s Liquidity?

Handing Money Transparent As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up the bank’s total assets. Generally, they should make up less than 70% of total assets, which is consistent with Guangzhou Rural Commercial Bank’s state given its much lower ratio of 45%. This ratio suggests that less than half of the bank’s total assets are made up of loans, but the bank’s strong liquidity management may be at the price of generating higher interest income.

What is 1551’s Liquidity Discrepancy?

1551 profits by lending out its customers’ deposits as loans and charge an interest on the principle. These loans may be fixed term and often cannot be readily realized, yet customer deposits on the liability side must be paid on-demand and in short notice. The disparity between the immediacy of deposits compared to the illiquid nature of loans puts pressure on the bank’s financial position if an adverse event requires the bank to repay its depositors. Relative to the prudent industry loan to deposit level of 90%, Guangzhou Rural Commercial Bank’s ratio of over 60% is markedly lower, which means the bank is lending out less than its total level of deposits and positions the bank cautiously in terms of liquidity as it has not disproportionately lent out its deposits and has retained an apt level of deposits. There is opportunity for the bank to increase its interest income by lending out more loans.

Next Steps:

Guangzhou Rural Commercial Bank meets all of our liquidity and leverage criteria, exhibiting operational prudency. The operational risk side of a bank is an important fundamental often overlooked by investors. The bank’s favourable liquidity and leverage position exposes it to less risk when it comes to repaying financial obligations, in particular, in the case of an adverse macro event. Today, we’ve only explored one aspect of Guangzhou Rural Commercial Bank. However, as a potential stock investment, there are many more fundamentals you need to consider. Below, I’ve compiled three important aspects you should look at:

  1. Future Outlook: What are well-informed industry analysts predicting for 1551’s future growth? Take a look at our free research report of analyst consensus for 1551’s outlook.
  2. Valuation: What is 1551 worth today? Has the future growth potential already been factored into the price? The intrinsic value infographic in our free research report helps visualize whether 1551 is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.