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Anyone looking for evidence of investors' deflating expectations for Chinese companies over the past few years need only glance at China's biggest banks. The four that listed in the pre-Lehman boom years priced at a minimum of three times their book value. Even Agricultural Bank of China, with a 2010 listing, managed a multiple of 2.5 times – more than twice the level for Western banks at the time. Now, the five biggest in China trade at just over book value. Yet all have defied the country's slowdown and lower analyst forecasts to produce strong first-quarter growth. Are China's banks now cheap?
It is not just the absolute multiple that is interesting. The five – ICBC, Bank of China, Agricultural Bank, China Construction Bank and Bank of Communications – are trading at their lowest-ever premium to European banks' times price to book. That put valuations in line with U.S. banks for the first time and China's banks have been trading at a discount to Asia's banks on times for almost a year – which is impressive given China's heavy index weighting.
Combined, the five have just produced profits growth of a tenth year on year and each met or beat expectations. Operationally, they are coping with 2012's interest rate liberalization which is slowly eating into their margins, and they are lessening their dependence on loan income with fee-based services.
So what is dragging their share prices lower? One factor is China's much-discussed, but hard to quantify, shadow banking system. Worries about loans structured as interbank assets to dodge lending caps, and investment products backed by murky pools of loans are the stuff of nightmares to anyone who suffered the financial crisis. The biggest banks are the least involved but the system's opacity means it is hard to know how any issue would manifest itself. That changes the question from one of value to one of whether investors believe Beijing is on top of this issue. The slide in price-to-book ratios suggests they are not at all sure, yet.