CHINA CONSTRUCTION BANK VALUATION

Author: D. Jaime Fernando Vara de Rey Campuzano

Supervisor: D. José Fernandez de Bilbao Ortega

Madrid

May 25, 2021

 Jaime Fernando Vara de Rey Campuzano – Bank Analysis and Valuation

This paper aims to provide an approximation to the intrinsic value of one of the largest financial
institutions in the world, namely, China Construction Bank. Even though its current market price should
be regarded as its fair value, we would try to demonstrate, through the use of different methodologies,
whether there is, if any, some sort of over or undervaluation. For that, we will first compare its current
value with the one deducted from a different group of peers and complement our initial review with
statistical methods to provide a more accurate picture.

An important disclaimer at this point should be made, though. Multiples valuation relies on the
Law of One Price, meaning that two identical entities shall trade at the same price. However, it is rather
difficult, if not impossible, to find two identical companies, mostly when it comes to these giants. This
is the main reason why any conclusions taken from this model should be carefully considered. Even if
the model is correct and provides a true fair value, the market can take the time or simply do not adjust
towards it. That said, we commence our discussion.

We have identified three categories of peers based on their similarities to CCB in terms of
business model, size, credit rating, and geographic diversification (for further information consult
Appendix I). For comparison purposes, we have begun with the first group and then add the second
and third categories. The first group, comprised of the most similar banks, is formed by the Industrial
and Commercial Bank of China (ICBC, the largest worldwide financial institution), and the Agricultural
Bank of China (ABC). Not only they derive their revenues from the most similar sources (mainly
Commercial & Retail Banking), but also have similar risk profiles, market cap and geographic
concentration. Bank of China (BOC) conforms to the second group as, even if it is quite alike in the
mentioned characteristics, it is more geographically dispersed, having a stronger exposure to Hong
Kong, Taiwan, and Macau. Lastly, the third group is formed by several Chinese banks with similar
operations and geographic concentration, but not directly comparable in terms of size and risk profile:
China Merchants Bank (CMB), Postal Savings Bank of China (PSBC), Ping an Bank (PAB), China
CITIC Bank Corporation (CCBC), China Minsheng Banking Corporation (CMBC), and China
Everbright Bank Company Limit (CEBC) conform this third category.

The valuation has been conducted in two ways. Firstly, based on 2020 financials, different
ratios have been obtained and used to determine the average, median, maximum, and minimum values
that should correspond to CCB and compare them with its actual one, as shown in Appendix II. This
process has been repeated four times to properly compare BBC with the three groups of peers (the fourth
comparative excludes CMB and PAB as they could be considered outliers). Secondly, an estimation of
CCB’s and its most likely peers’ (Groups 1 & 2: ICBC, ABC, and BOC) P&L and part of their capital
accounts has been undertaken to forecast their 2021, 2022 and 2023 Return on Equity, Return on
Tangible Equity, Price to Book Ratio, and Price to Tangible Book Ratio to run a statistical regression
 Jaime Fernando Vara de Rey Campuzano – Bank Analysis and Valuation

and examine any possible under or overvaluation in the following years. These forecasts can be
consulted in Appendix III. For the rest of banks, direct estimates from Capital IQ have been used.

The first comparative assessment provides different results. When comparing CBB with both
ICBC and ABC using the average equity value provided by the Price to Earnings, Price to Book, and
Tangible Price to Book Ratios we conclude that CCB is undervalued (1.293 trillion CHY Market Cap
against the 1.36 trillion provided by the peers). The conclusion is the opposite, however, when we
include BOC, with a provided value of roughly 1.28 tr CHY. We must recall that BOC can be arguably
excluded from the comparable analysis due to its higher diversification.

A better conclusion can be reached by studying the value drivers, since an a priori under or
overvaluation may not be genuinely justified if they are not aligned. Whereas Return on Equity,
Dividend Pay-Out Ratio and Sustainable Growth Rate are positively correlated with Value, Required
Rate of Return is not. In terms of ROE, CCB leads the ranking with 11.83%, followed by ICBC
(11.24%), BOC (9.91%), and ABC (9.66%). Its Sustainable Growth Rate is also high (8.07%) but lower
than that of ICBC (8.3%). ABC and BOC show less growth potential, 6.42% and 6.52%, respectively.
Nonetheless, CCB’s cost of equity (implied from market values) is the highest (15.33%), compared to
ICBC's (14.4%) and ABC (13.34%), which may be leading to its supposed undervaluation. The
dividend payout ratio is similar for the four banks (with BOC’s being the highest). The value drivers do
not provide a sound justification so we cannot discard our initial findings. When we add the third group
of banks (both including and excluding CMB and PAB due to their current extreme values) the results
are yet unclear, pointing to both an over and undervaluation.

Figure I - Relative Valuation Ranges (Trillion CHY)

Main, Similar & Other Comps Ex CMB & PAB

Main & Similar Comps

Main Comps

0.90 1.00 1.10 1.20 1.30 1.40 1.50 1.60 1.70 1.80

Max Min

In Figure I we can see the different outputs, with the black line pointing to the actual CCB’s
Market Cap. Logically, by including just the most similar banks (ICBC and ABC) we get the tightest
range, of around 0.3 trillion CHY. The current market value falls within this range and CCB’s
undervaluation may be justified (although it could also be caused by the higher yield required by
investors, as we have already seen).
 Jaime Fernando Vara de Rey Campuzano – Bank Analysis and Valuation

The second part of the analysis makes use of statistical methods, including both Return on
Equity and Price to Book Value, to see whether our initial suspicions could be statistically sound. As
mentioned, various accounts have been forecasted for the main peers while relying on published
estimates for the rest of the institutions, data that can be consulted in Appendix IV. The forecasts are
based on the belief that the economic recovery will begin in 2021 and take hold in the subsequent years.
However, due to lower yields to support economic growth and expected defaults in the near term,
margins are not expected to rapidly improve, while provisions are expected to remain high at least in
the present year.

While we have based our predictions on public research on the different assessed entities, when
compared to consensus estimates, the conclusion is that we have been overly optimistic by forecasting
a more rapid than expected recovery and growth in the Asian nation, leading to upward trends in mostly
every valuation indicator. Increased competition, stagnant interest rates in the medium term and slowed
systematic GDP growth are all factors to which the downward trend in most consensus estimates shall
be attributed.

Different regressions have been run, corresponding to the years 2020, 2021, 2022 and 2023,
where the values of the different peers are put in perspective to determine the actual degree to which
their Price to Book Values can be explained by their Return on Equities. We cannot forget that
mathematically speaking, Price to Book is related to ROE, however, we shall investigate to what extent
that relationship holds in real life.

Once we obtain the different regression functions, we can estimate, from the existing and
forecasted levels of ROE (independent variable), the corresponding Price to Book Ratio which we can
use to arrive at an objective Market Capitalization. These results can be reviewed in Table I.

Results point to a potential undervaluation, with the estimated value exceeding the current one
by more than 6%, a significant amount. The obtained results are rather similar to those got when using
the Main Comp’s comparables (roughly 10 million higher), probably confirming them. However, they
differ to a great extent from those provided by the rest of the comparables which, as repeated throughout
the paper, maybe should not have been compared at all.

Another regression has been conducted, this time comparing CCB with the biggest European
& American Banks (see Appendix V) Even though the results also indicate that CCB is currently
undervalued, results are extreme and to a very extent unreliable, as we are basing CCB’s objective P/B
value on banks that are not objectively comparable as suggested by their geographic presence, market
cap, business models, and mostly every other aspect. Chinese banks are very particular in terms of the
business activities they are engaged in and because of the specific features of China. However, it is
always interesting to grab an idea of how these banks differ amongst others.
 Jaime Fernando Vara de Rey Campuzano – Bank Analysis and Valuation

2020 2021 2022 2023

CCB Book Value 2,389,353 2,587,805 2,809,899 3,053,559
Objective P/B - Asia 0.58 0.56 0.59 0.58
Objective P/B – Eur./Am. 1.10 1.16 1.24 1.16
Actual Market Cap 1,293,948
RA - Asia 1,376,010 1,452,629 1,668,701 1,786,300
RA – Europe & America 2,619,007 3,008,487 3,485,096 3,556,524
Main Comps’ MC 1,366,748.07
Similar Comps’ 1,280,435.35
Other Comps’ MC 1,253,512.61

Table I: Regression & Comparables Results

We have thus seen how the valuation exercise is not as simple as it may have thought to be.
The initial decision to select the appropriate peers is already challenging as care must be taken to not
include those institutions which may not be completely related to the subject one and which could distort
the valuation exercise from the very first moment. Once the different categories had been established,
we see how, depending on the specific peer group on which we derive the comparable value, the
valuation provides fully different results, which adds another layer of complexity. In this regard, we are
particularly inclined to just use the first and most similar group, based on which we had obtained an
intrinsic value slightly above the market one, 5.6% to be more specific (or CHY 1,366,748.07 mm,
compared to the CHY 1,293,947.80 mm current market cap), resulting in CBB currently being
undervalued. The conclusion is the opposite though, when we add more "comparables” to the sample,
as in this case values are -1.95% (with Similar Comps) and -3.12% (with Other Comps), leading to an
a priori CBB’s overvaluation. For the reasons stated above, we prefer to solely rely on the results
provided by using the Main Comps, as their intrinsic characteristics allow them to best rely on the Law
of One Price.

Regression results provide similar ones to those obtained through the comparables method,
reaching the same conclusion that when using the Main Comps Group. In this regard, we first see in
Appendix IV and V that CBB appears to be located under the regression line, thus being the quickest
method to detect its undervaluation, confirmed by estimating the Price to Book Ratio for the current
ROE through the regression model, on which we got a value 6% above the current one (or CHY
1,376,009.92 mm). The regressed marked cap is quite similar to the Main Comparables’ market Cap,
providing sound support to our initial hypothesis. The results obtained by using the European &
American counterparts provide for the same conclusion but differ in magnitude. In any case, we prefer
to stick to the results provided by the Chinese Banks.
 Jaime Fernando Vara de Rey Campuzano – Bank Analysis and Valuation

However, we should not disregard the current market value as the true value indicator for many
reasons. Hence, the use of the comparables method only holds when the peers used are truly similar to
the subject institution, in which case they should trade at the same price. The peers used, although
roughly similar, show some differences in terms of business operations, size, capital ratios and other
key indicators, so we must remain cautious when making such valuation statements. The regression
model also entails more uncertainties, as its accuracy is dependent on the size of the sample used, which
is quite limited in our case; the observance of the necessary regression assumptions (independent
variables uncorrelated with the residuals, zero expected random error, constant variance of random
error, uncorrelation among random errors and so on); and the inexistence of model misspecifications
(omitting variables, variable transformation and so on). The obtained R-Squares (proportion of the
dependent variable’s variation explained by the independent variables) are not substantially high, so we
must be also careful when making inferences from the results obtained. Lastly, any remaining
differences not attributable to the valuation method can be explained by the fundamental differences of
the subject company, whose real sustainable growth and required return could differ from its peers,
giving solid grounds to the possible undervaluation.
 Appendix I
Comparables’ Review

Market Cap
Credit Rating Mainland China Loan Book Commercial & Retail Banking Tier 1 Capital Ratio Stable Funding Ratio
(CHY mm)
Main Comps
ICBC 1,766,131.6 A / Stable 91% 88.80% 13.70% 131.70%
ABC 1,115,751.9 A / Stable 94% 85.20% 12.92% 135.60%

Similar Comps

BOC 907,526.0 A / Stable 81% 81.80% 13.19% 116.10%

Other Comps

CMB 1,399,015.6 BBB+ / Stable 97% 95.60% 12% 115.70%

PSBC 466,969.7 A / Stable 100% 84.20% 11.50% 151.60%
PAB 462,249.0 BBB+ / Negative 100% 94% 11.40% 103.10%
BoCom 340,995.5 A- / Stable 94% 92.60% 12.90% 120.60%
CCBC 231,042.0 BBB+ / Stable 95% 83.80% 10.30% 101.40%
CMBC 194,933.8 BBB- / Stable 97% 94.10% 9.50% 94.90%
CEBC 193,667.9 BBB+ / Stable 100% 83.10% 10.40% 107%

CCB 1,293,947.8 A / Stable 90% 85.50% 14.22% 126.20%

 Appendix II
Comparables Valuation Summary

Price to Earnings Price to Book Value Price to Tangible Book Value

Main Comps
Average 5.36 55% 58%
Median 5.36 55% 58%
Maximum 5.56 61% 65%
Average Implied Equity Value 1,465,747.35 1,312,297.39 1,322,199.47
Median Implied Equity Value 1,465,747.35 1,312,297.39 1,322,199.47
Maximum Implied Equity Value 1,520,929.59 1,450,383.26 1,477,348.36
Minimum Implied Equity Value 1,410,565.11 1,174,211.53 1,167,050.57

Current Equity Value 1,293,947.80

Total Average 1,366,748.07 Undervalued
Total Median 1,366,748.07 Undervalued
Total Maximum 1,482,887.07 Undervalued
Total Minimum 1,250,609.07 Overvalued

Main & Similar Comps

Average 5.05 51% 55%
Median 5.16 49% 51%
Maximum 5.56 61% 65%
Minimum 4.42 42% 49%
Average Implied Equity Value 1,380,683.34 1,209,055.62 1,251,567.10
Median Implied Equity Value 1,410,565.11 1,174,211.53 1,167,050.57
Maximum Implied Equity Value 1,520,929.59 1,450,383.26 1,477,348.36
Minimum Implied Equity Value 1,210,555.33 1,002,572.07 1,110,302.37

Current Equity Value 1,293,947.80

Total Average 1,280,435.35 Overvalued
Total Median 1,250,609.07 Overvalued
Total Maximum 1,482,887.07 Undervalued
Total Minimum 1,107,809.92 Overvalued
 Price to Earnings Price to Book Value Price to Tangible Book Value
Main, Similar & Other Comps Ex CMB & PAB
Average 5.25 47% 52%
Median 5.13 42% 49%
Maximum 7.26 69% 75%
Minimum 4.29 36% 39%

Average Implied Equity Value 1,436,740.76 1,134,476.08 1,189,320.97

Median Implied Equity Value 1,404,180.73 1,009,794.84 1,129,400.88
Maximum Implied Equity Value 1,986,272.95 1,658,055.75 1,715,181.75
Minimum Implied Equity Value 1,172,416.84 860,540.20 899,984.69

Current Price 1,293,947.80

Total Average 1,253,512.61 Overvalued
Total Median 1,181,125.48 Overvalued
Total Maximum 1,786,503.48 Undervalued
Total Minimum 977,647.24 Overvalued
 Appendix III
Financials Forecasts

ROE ROTE P/B P/TB

2021 2022 2023 2021 2022 2023 2021 2022 2023 2021 2022 2023
Main Comps

ICBC 11.68% 12.06% 12.41% 12.42% 12.8% 13.18% 0.54 0.58 0.63 0.66 0.72 0.77
ABC 10.01% 10.26% 10.59% 10.49% 10.81% 11.13% 0.502 0.527 0.564 0.574 0.612 0.65

Similar Comps
BOC 10.03% 10.31% 10.56% 11.64% 12% 12.31% 0.42 0.44 0.46 0.62 0.65 0.69

Other Comps
CMB 15.62% 16.06% 16.45% 1.91 1.69 1.5
PSBC 11.20% 11.46% 11.69% 0.63 0.58 0.53
PAB 10.23% 10.76% 11.80% 1.39 1.25 1.13
BoCom 9.71% 9.76% 9.88% 0.40 0.38 0.36
CCBC 9.63% 10.01% 10.58% 0.33 0.31 0.28
CMBC 7.46% 8.07% 7.89% 0.42 0.38 0.37
CEBC 10.02% 10.30% 10.63% 0.56 0.50 0.48

CCB 12.07% 12.48% 12.63% 12.71% 13.19% 13.33% 0.5407 0.5814 0.5978 0.630 0.686 0.701
 Appendix IV

Regression Analysis - Asia

y = 4.2235x + 0.0514
2020 Main, Similar & Other Comps Ex CMB, PAB y = 4.399x0.9526 2021 Main, Similar & Other Comps Ex CMB, PAB R² = 0.3671
R² = 0.5186
80% 80%

70% 70%
PSBC PSBC
ICBC
60% 60% CEBC
ICBC

P/B
P/B

ABC ABC
50% CCB 50% CCB
CEBC BOC CMBC
BoCom
40% CMBC 40% BoCom BOC
CCBC CCBC

30% 30%
6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0%
ROE ROE

y = 6.0288x - 0.1584 y = 5.9031x - 0.1607

2022 Main, Similar & Other Comps Ex CMB, PAB R² = 0.6122 2023 Main, Similar & Other Comps Ex CMB, PAB R² = 0.5056

75% 75%

ICBC
65% 65%
PSBC ICBC
ABC CCB
ABC PSBC
55% CCB 55%

P/B
P/B

CEBC
CEBC
45% 45%
CMBC BOC CMBC BOC
BoCom
35% BoCom CCBC 35%
CCBC

25% 25%
6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0%
ROE ROE
 Appendix

Regression Analysis – Europe & America

y = 6.6365x + 0.3109 y = 8.0005x + 0.1966
2020 R² = 0.5157 2021 R² = 0.6696
180% 200%
JPM JPM
160% 180%
MS 160% MS
140%
140% BoA
120% GS
BoA GS
120%
100%
100% UBS
Citi
80% Intesa UBS Intesa
CCB 80%
60% HSBC BNP HSBC
ABN ING City CCB
ING 60%
Santander BNP
40%
40% Santander
SG DB
20%
20% SG
0%
0%
0% 2% 4% 6% 8% 10% 12% 14%
0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

y = 10.537x - 0.0745 y = 10.509x - 0.1628

2022 R² = 0.6664 2023 R² = 0.7021
180% 180%
JPM
JPM
160% 160%
MS
140% BoA 140% MS
GS BoA
120% 120%

100% 100% GS
UBS
UBS
80% Intesa ING ING Intesa
80%
HSBC HSBC CCB
CCB
60% ABN City ABN
60% City
DB BNP DB
Santander BNP Santander
40% 40%
SG SG
20% 20%

0% 0%
3% 5% 7% 9% 11% 13% 15% 2% 4% 6% 8% 10% 12% 14%