Industrial Securities has shifted towards high-end wealth management in recent years.
Although it has held off on cutting commission rates, its brokerage market share is nowregistering modest declines (2015: -5% YoY; 4M16: -3%) . We are concerned aboutdownside risk to its share in brokerage given intensifying industry competition and ahigher-than-average commission rate in Q1 (0.045%). Meanwhile, its share in marginlending has remained stable for many years. Considering Industrial’s abundant capitaland strong customer mix, we think its flow-based business could enjoy rapid growth ifthe market recovers.
Administrative penalty from CSRC; investment banking unit back to normal.
On 8 July 2016, the company received a notice of administrative penalty from theCSRC. The regulator imposed Rmb57.38m in penalties on Industrial Securities(confiscati ng Rmb12m in IPO sponsorship revenue along with a Rmb24m fine, andconfiscating Rmb20.78m in underwriting income along with a Rmb600k fine). Inaddition, the company has proactively set aside Rmb550m to set up a specialcompensation fund for investors in Xintai Electric. Though Industrial’s investmentbank ing business has recovered earlier than we or the market expected, we believe itsbrand and investment banking business have both sustained some damage.
Lowering 2016-18E earnings on weak market activity and fiercer competition.
We are downgrading our 2016-18E EPS 43%/26%/18% to Rmb0.28/0.40/0.48, basedon the following: 1) we are lowering our 2016-18 core sector assumptions (ADT andaverage margin lending balance); 2) we are lowering our 2016-18E investment yield forthe company, given an overall drop in investment yields; 3) the aggregate NPAT (at theparent company level) of Industrial was Rmb894m in 5M16; and 4) the direct andindirect impact of the regulatory penalty.
Valuation: New Rmb9.45 price target; upgrading to Buy.
We are changing our valuation method to PB/ROE given industry characteristics.
Assuming a stable market, we estimate average ROE of 8.8% in the next 5 years andlong-term sustainable ROE of 10.0%. We derive our new Rmb9.45 PT by applying2.00x P/ B to our 2016E BVPS, implying 23.6x 2017E PE and 1.87x 2017E P/B. Webelieve the market has overreacted, as we foresee only a minor impact on mid/longtermprofitability from the investigation. Therefore, we upgrade the stock to Buy fromSell.