I purchased H-shares of the Industrial and Commercial Bank of China (ICBC) for my Dividend Income Portfolio. Here are the reasons why.

Summary

In this article, I examine the stock valuation of the H-share of the Industrial and Commercial Bank of China (ICBC 1398.HK) through the eyes of a Dividend Investor. Dividend Cash Flow analysis was used to evaluate ICBC's H-share (1398.HK). The Dividend Discount Model was employed to calculate the H-share Intrinsic Value, Expected Return on Investment, and its Margin of Safety.
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Introduction

In a previous article, I looked at certain China H-shares as good investment candidates for dividend income. Since then, I have invested in some of the same companies discussed in that article, including the H-share of the Industrial and Commercial Bank of China (ICBC). Here, I would like to discuss the rationale behind the investment decision to purchase the H-shares of ICBC for my dividend income portfolio.

Over the years, my approach to investing has evolved from the speculative growth and momentum style to a more conservative method, preferring stocks that provide attractive dividend income streams at inexpensive valuations. I used the following set of questions to help me determine the investment worthiness of the H-share of ICBC:

• • Does ICBC have a good long-term dividend track record?

• • Does ICBC currently offer an attractive dividend yield (above the average yield of Hang Seng Index constituents)?

• • Is the current payout ratio of ICBC sustainable?

• • What is the expected return on investment of ICBC over a 10-year period? The majority of recommendations by financial analysts tend to have a 12-month time horizon. I find the 10-year period to be more suitable for a dividend income stock, especially one which is part of a retirement dividend income portfolio.

• • Does the H-share of ICBC offer a sufficient margin of safety to the intrinsic value of the stock?

• • Are the H-shares of ICBC considered inexpensive when measured according to traditional value investing yardsticks? A good dividend stock with an inexpensive valuation will minimize the risk of capital impairment and increase the probability of capital gains.

With the above questions in mind, let us delve into the analysis of ICBC H-share to find the answers.

Background Information on the Industrial and Commercial Bank of China (ICBC)

The Industrial and Commercial Bank of China (ICBC) is China’s largest commercial bank in terms of assets and is also one of the largest in the world. Its largest shareholder is the Central Government of China which controls over 70% of the voting rights through multiple state-owned entities, the biggest two being Central Huijin Investment Ltd (34.71%) and the Ministry of Finance (31.14%). Hence, ICBC is considered as a state-owned commercial bank and is one of the largest state-owned enterprises in China.

Does ICBC have a good long-term dividend track record?

ICBC has an uninterrupted track record of dividend payment since its dual listing on the Shanghai Stock Exchange and the Hong Kong Stock Exchange on 27th October 2006.

Data Source: ICBC-Ltd.com

As the track record shows, ICBC’s dividend per share has grown steadily from 0.133RMB per share in FY2007 to 0.266RMB per share in FY2020, growing at a compounded annual growth rate of 5.48%.

More importantly, ICBC continued to pay a full dividend in the year 2020, a year in which the world economy was severely affected by the Covid-19 health crisis. In the same year many banks around the world, including European banks and American banks were forced to severely reduce or eliminate their dividend payments. This is testimony to ICBC’s impressive dividend track record since its public listing in 2006.

Does ICBC currently offer an attractive dividend yield (above the average yield of Hang Seng Index constituents)?

For FY2020, ICBC declared dividends of 0.266RMB per ordinary share, which is equivalent to 0.3199HK$. On 6th August 2021, the H-share of ICBC closed at 4.29HK$ per share. This translates into a dividend yield of 7.46% which is substantially higher than the average dividend yield of the constituent stocks of Hang Seng Index.

Data Source: AAStocks.com

Is the current payout ratio of ICBC sustainable?

In the last 6 years (FY2015 to FY2020) the dividend payout ratios of the major China Banks, including ICBC, have stabilized at around the 30% to 30.5% level.

Data Source: CGS-CIMB Report on China Banks dated 28 July 2021

CGS-CIMB, in their report on China Banks titled “In Dividends We Trust” dated 8th April 2020, put forward 6 reasons why the dividend payout ratios of the large Chinese State-Owned commercial banks are considered to be sustainable at current levels (Quoted verbatim from page 7 of the said report):

1. 1. Ownership structure of these large banks, and the importance of their dividends to central government revenues.

1. 1. Regulatory reasons which may discourage the banks from making large cuts to the payout ratios, with special significance around the 30% level.

1. 1. The large China banks' 30% dividend payout ratio levels are by no means aggressive, and are well below the global bank median.

1. 1. Capital ratios look more than adequate for the large banks relative to minimum regulatory requirements.

1. 1. Dividend payout ratio cuts do not save much Tier 1 capital, so there is little point in slashing the dividend payout to save capital.

1. 1. Slower loan growth as well as continued shift in loan book mix towards retail and away from corporate going forward means less pressure on capital, even after factoring in the falling pace of organically generated capital. Falling provisioning coverage ratios for some of the mid-large banks could also boost core Tier 1 ratios.

The above 6 reasons given by CGS-CIMB make a strong case for the sustainability of the dividend payout ratio of ICBC.

What is the expected return on investment of ICBC over a 10 year period?

A cash flow analysis was carried out to determine a reasonable estimate of the expected return on investment of ICBC H-share over a 10-year period. The Dividend Discount Model was adopted. Key parameters for the cash flow model are as follows:

1. 1. Period = 10 years

1. 1. Terminal growth rate = 3%

1. 1. Risk Free Rate = 1.21% (Risk Free Rate for June 2021 according to Market Risk Premia)

Data Source: market-risk-premia.com

4. 4. HK Stock Market Risk Premium = 10.5% (Approximately equal to the Market Risk Premium at the depths of 2008 Global Financial Crisis according to Market Risk Premia)

Data Source: market-risk-premia.com

5. 5. ICBC Stock Beta = 1.0 (This is a conservative estimate. According to the Financial Times, the beta is around 0.815)

Data Source: CGS-CIMB Report on China Banks dated 28 July 2021

7. 7. Currency Exchange Rate = 1.20 HK$/RMB

7. 7. Discount Rate = Risk Free Rate + Beta x Market Risk Premium = 1.2% + 1(10.5%) = 11.71%

From the above cash flow model, the following values are calculated:

1. 1. Total of Discounted Dividends (FY21 to FY30) = 1.784RMB

1. 1. Expected Price to Book Value Ratio in FY30 = (ROE-g)/(K-g) = (8.47%-3%)/(11.71%-3%) = 0.628

1. 1. Expected Book Value of ICBC in FY30 = 14.81RMB

1. 1. Expected Stock Price in FY30 = 0.628 x 14.81 = 9.30RMB

1. 1. Present Value of FY30 Stock Price = 9.30/(1.1171)^10 = 3.074RMB

1. 1. Estimated Intrinsic Value of ICBC = 1.784 + 3.074 = 4.858RMB which is equal to 5.83HK$

Based on the discounted cash flow model, the intrinsic value of the H-share of ICBC is estimated to be approximately 5.83HK$ per share when discounted at the rate of 11.71% per annum.

One way to interpret the results above is that an investment into the H-share of ICBC at a price of 5.83HK$ is expected to provide a return on investment of 11.71% per annum over a 10-year period.

The goal seek function of Excel can be used to find a discount rate that will yield an intrinsic value equal to the purchase price of 4.29HK$. This discount rate is found to be equal to 14.07%. In other words, an investment into the H-share of ICBC at a price of 4.29HK$ is expected to provide a return on investment of 14.07% per annum over a 10-year period.

Does the current stock valuation of ICBC offer a sufficient margin of safety?

On 6th August 2021, ICBC's H-share price closed at 4.29HK$ per share. With an estimated intrinsic value of 5.83HK$, this translates into a comfortable margin of safety of 26.42%.

Are the H-shares of ICBC considered inexpensive when measured according to traditional value investing yardsticks?

Some popular yardsticks to gauge the value of stocks as investments include the Price to Earnings ratio, Price to Book Value ratio and “percentage off the 52-week low/high”. In this section we will see how the H-share of ICBC measures up against these benchmarks. Based on the ICBC H-share price of 4.29HK$ per share, the following observations are made:

• • Trailing PE Ratio = 4.19.
    • • The price represents an opportunity to own a stake in the largest commercial bank in the world, in terms of assets, at an attractive discount with a payback period of less than 5 years.

• • PBV Ratio = 0.46.
    • • The Return on Equity of ICBC in FY2020 is 11.95%. Using a discount rate of 11.71% and a growth rate of 3%, the PBV can be estimated to be 1.02. Applying a 30% discount to this estimated value implies a fair PBV of 0.714. This represents an upside of 55% from the current PBV of 0.46.

• • % off 52-week low/high.
    • • The stock price is hovering at 8.33% above the 52-week low and 34% below the 52-week high. This implies that the stock has experienced a major correction and is now at the lower end of its 52-week trading range. While momentum traders will have a different opinion, I usually find a stock to be a bigger bargain when it is hovering near to its 52-week low than when it is soaring close to its 52-week high.

In addition, ICBC has a consistent track record of positive earnings since its public listing and the historical earning per share from Fiscal Year 2007 to 2020 are as tabulated below. It is worth noting that from 2010 to 2020, the earnings per share of ICBC grew at a compounded annual growth rate (CAGR) of 6.0%.

Summary and Conclusion

In this article, I set out to document the rationale behind my recent investment decision to purchase the H-shares of ICBC for my dividend income portfolio. The many reasons I found ICBC H-share to be an attractive investment can be summarized as follows:

1. 1. ICBC has a good long-term dividend track record.

1. 1. ICBC currently offers an attractive dividend yield which is higher than the average yield of Hang Seng Index constituent stocks.

1. 1. The current payout ratio of ICBC is sustainable.

1. 1. An investment into the H-share of ICBC at a price of 4.29HK$ is expected to provide a return on investment of 14.07% per annum over a 10-year period .

1. 1. The intrinsic value of ICBC H-share is estimated to be 5.83HK$ per share, representing a 26.42% margin of safety over the price of 4.29HK$.

1. 1. The H-shares of ICBC are currently trading at inexpensive valuations when measured against traditional value investment yardsticks.

Disclaimer:

This article is a record of the thinking behind a personal investment decision. It does not represent any recommendation to purchase any stock mentioned in the article. As always, readers are strongly advised to do their own due diligence before making any investment decisions.