Description

Main points

Postal Savings Bank of China (“PSBC”) is one of China’s largest retail banks with 10% market share and the largest branch network in the country. Since 2015, PSBC has grown assets by 9% a year and net income by 13% a year. PSBC averages 13% ROEs, but those will likely go up a bit as the financialization of the economy, a top priority for the CCP, gets underway.

PSBC sells for 4.3x earnings and just .5x book value. To give this context, historically the average stock in the S&P 500 has 12% ROE, 6% EPS growth and trades at 1.4x book value. PSBC meanwhile has slightly higher ROE and double the growth, yet it trades at one-third the valuation. There was a time when China’s largest banks traded close to or above book value, and we believe that once tensions between the US and China normalize, those valuations will be seen again.

On top of this, as a bank that largely serves rural areas, PSBC is poised to be a major beneficiary of the CCP’s push to ramp agricultural output and revitalize the countryside, as outlined in its recent five-year plan. Leon Levy’s biography impressed upon me the value of investments poised to benefit from major government initiatives. PSBC is one such investment. I think the stock is worth 130% more from where it currently trades.

One other important factor: Li Lu has, by my guess, 5% of his fund invested in PSBC. He’s listed in their annual report each year as one of the largest shareholders, which means unlike most of his investments, this one is quite public, thus putting his reputation on the line. Obviously a Chinese bank, like any bank, is a black box to us, but having Li Lu as an insider here suggests things are more likely to be on the up and up.

The business

PSBC is one of six state-owned commercial banks in China. It has the largest number of branches, allowing it to reach almost half of China’s population. The bank is irreplaceable due to its extensive presence in underbanked rural areas. However, all this comes with a major catch. 80% of its branches are owned by its parent company, China Post Group. And PSBC must pay a fee to China Post for all deposits collected through the branches. It must also pay out most of its fee and commission income to China Post.

Despite this severe limitation, PSBC consistently earns 13% ROEs and is growing earnings double digits. But really what makes PSBC compelling right now is that it’s about to receive a major tailwind as the beneficiary of several major government initiatives:

(1) the financialization of the Chinese economy,

(2) the 14^th Five year plan emphasizes rural revitalization and increased food production

(3) common prosperity.

As mentioned, PSBC is prominent in rural areas. This is significant because rural revitalization is a centerpiece of the CCP’s few five year plan. In response to the pandemic, geopolitical conflicts and global food supply issues, the CCP has committed to making China far more self-reliant in terms of being able to feed its 1.4 billion people. Subsidies are being increased, and new agricultural technologies are being utilized. Per Tang Renjian, China’s minister of agricultural and rural affairs, “we must produce and store more grains as much as possible.”

Bottom line: All three initiatives are both significant to China’s long-term interests and significant to maintaining the moral legitimacy of the Communist party in the country. As a result, more wealth will likely be flowing into rural areas and lower tier cities, which helps PSBC and its customers.

Risks

The biggest risks facing PSBC are: (1) Evergrande/real estate contagion, (2) potential US sanctions and (3) recession in China.

In terms of real estate risk, the Evergrande contagion has rightfully spooked investors. That said, at PSBC, real estate comprises 37% of total loans. 92% of that is mortgages, and only 8% of that are loans to developers, which means property risk is low.

The second biggest risk is sanctions from the US stemming from the war in Ukraine. It’s telling, however, that the state-owned Chinese banks haven’t crashed along with the rest of Chinese stocks. This is because the US has taken no action against them and is unlikely to. Doing so would cause far-ranging financial disruption for both countries, and thankfully so far there seems to be very little appetite on either side to do that.

Regarding recession risk, I think one of the biggest risks here is that the US goes into a recession and the rest of the world follows. China is such a different country from what it was even 10 years ago that we can't really rely on what's happened historically there to guide us. Instead what gives me faith here is that, despite what critics say, China's growth isn't the result of a debt bubble. They have one of the most talented labor pools in the world and graduate far more STEM professionals than we do. They've made technological gains that have eluded the US. Just look at a video of Alibaba's smart warehouses or one of China's intelligent ports.  Their economic growth is not only real, it's poised to continue for a long time. A recession would only postpone China's future, not derail it. 

Valuation

There seems to be very little interest in sleepy old PSBC. The highest sell-side price target I found was 7.03 HK from Nomura, implying 50% upside. Currently, despite 13% ROEs, PSBC trades at .5x book value. Given its long and high-percentage growth runway, PSBC should trade at a price to book that reflects its ROE. I think 1.2x book is achievable, which suggests there’s 130% upside.

Catalyst

• Passage of time
• Easing of tensions between China and the US
• China continuing to show that its economics are the real deal and not a product of debt growth