CHINA HUARONG ASSET MANAGEMENT(02799.HK)：WATCH THREE AREAS AMID BUSINESS TRANSITION-格隆汇

机构：中金公司
研究员：Jiahui YAN/Jiaoyang LU/Shuaishuai ZHANG

Investment positives
We initiate coverage on China Huarong Asset Management with a NEUTRAL rating and a target price of HK$0.39 (0.44x 2022e P/B).
Why a NEUTRAL rating?
Upbeat on growth potential of distressed asset management business due to nature of such business. Distressed assets are continuing to increase, as we believe China's economy is at a structural transition stage. Although the statistics are incomplete, we calculate outstanding distressed assets in China rose by Rmb2.7trn YoY at end-2021 to Rmb5.2trn, with Rmb2.2trn in distressed assets disposed of in 2021. The distressed assets covered by the incomplete statistics include non-performing loans (NPLs) at commercial banks, NPLs at non-banking financial institutions, defaulted credit bonds, and bad accounts receivable at industrial firms above a designated scale . Factoring in special mention assets, we estimate outstanding distressed assets exceeded Rmb10trn at the end of 2021.
As one of four major state-owned AMCs, China Huarong accounts for high share of distressed asset management market. Four major state-owned asset management companies (AMC) - China Huarong, China Cinda, China Orient, and China Great Wall Asset Management - were established in 1999. We think AMCs play a key role in mitigating financial risks. We believe China Huarong and other state-owned AMCs may continue to account for a high share in the distressed asset management market on the back of their shareholders and extensive experience in this industry.
Has withstood pressure of business transition; watch three areas of firm. China’s distressed asset management industry is large. However, China Huarong Asset Management (China Huarong) has withstood pressures from a business transition amid intensified competition, from increased difficulty in business operations, and from a lack of effective corporate governance. Since 2019, the firm has entered a transition stage to revert to its main business (distressed asset management) and mitigate existing risks. It continues advancing the transition program after introducing strategic investors in 2021. We suggest investors watch three aspects of the firm: 1) the new management team and their operational rationale; 2) the recognition of impairment losses and future asset quality; and 3) the fine-tuning of the business structure and the capability to tackle distressed assets after the firm shifts its focus back to its main business.
How do we differ from the market　　The market is skeptical about the effect of China Huarong's attempts at improving asset quality and increasing profitability. The firm has improved its compliance and internal control, and reduced asset risks after introducing SOEs as strategic investors. It has also focused more improving profitability and making its business operations more sustainable. We suggest watching China Huarong, given what we believe is the growth potential of the distressed asset management industry.
Potential catalysts: Asset quality continues to improve; the firm disposes of its non-distressed asset management businesses and enhances its profitability.
Financials and valuation
We estimate the firm's EPS will reach Rmb0.01 in 2022 and Rmb0.02 in 2023, implying a CAGR of 83.5%. The stock is trading at 0.39x 2022e and 0.38x 2023e P/B. We initiate coverage of China Huarong with a NEUTRAL rating, and derive a target price of HK$0.39 from a SOTP valuation methodology and scenario analysis. Our TP implies 0.44x 2022e and 0.43x 2023e P/B, offering 13.3% upside.
Risks
Asset quality deteriorates; profitability of distressed asset management business weakens more than we expected due to rising acquisition costs and lower return rates of asset disposals; liquidity issues due to a mismatch between the structures of assets and liabilities; internal control and compliance system disappoints.