This article first appeared in The Edge Malaysia Weekly on September 16, 2024 - September 22, 2024

HONG Leong Bank Bhd (KL:HLBANK) (HLBB) is in no hurry to make any decision on its 19.8% stake in Bank of Chengdu Co Ltd (BoCD), its chief says, amid talk that the Malaysian lender may be looking to trim its stake in the Chinese bank.

“We are in no hurry to make any decisions,” HLBB group managing director and CEO Kevin Lam tells The Edge when asked if it currently has plans to trim its BoCD stake.

“China remains a core part of our long-term investment strategy and we take a long-term view on this. We are committed to a measured and deliberate approach that maximises value creation over the long term. Any future corporate actions will be carefully considered and executed strategically,” he says in an email response to questions.

Analysts note that while BoCD is undoubtedly proving to be a good investment for HLBB, a key challenge for Malaysia’s fifth largest banking group by assets is trying to balance out the robust earnings contribution from BoCD with that of its own franchise.

“We understand that there has been consideration to trim its share in BoCD, as this would balance the earnings contribution from its own franchise vis-à-vis BoCD’s contribution, as well as to enable capital to be released as CET-1 (common equity Tier-1) capital,” Affin Hwang Investment Bank Research says in a Sept 11 report.

BoCD’s contribution to HLBB’s earnings has grown strongly over the years. It contributed to 31% of HLBB’s profit before tax in the financial year ended June 30, 2024 (FY2024) as compared to just 17.4% in FY2019. 

TA Securities projects that this could increase to 41% by FY2027, given that BoCD’s earnings are expected to grow strongly in the next few years. Analyst consensus estimates see BoCD’s net profit growing by 11% to 12% annually for the next three years.

Lam points out that there will, anyhow, eventually be a natural dilution of HLBB’s stake to around 17.8%.

“It is important to note that there will be some natural dilution of our equity stake in BoCD as the remainder of BoCD’s minority shareholders exercise their convertible bonds (C-bonds). This will likely bring our stake to around 17.8%, which is the same level [as what it was] before we invested in the C-bonds, a level we consider appropriate for the time being,” he says.

For context, HLBB had in March 2022 subscribed to C-bonds issued by BoCD and fully converted them into equity — a move that raised its stake to the present 19.8%. But, there are still about RMB5 billion worth of C-Bonds held by minority shareholders that have not been converted. The conversion is expected to happen over the next one to two years.

Asked how HLBB plans to keep pace with BoCD’s growth considering potentially slower economic expansion in Singapore — one of its overseas markets that HLBB is particularly counting on to step up — Lam says: “BOCD is expected to grow profits at a healthy 10% rate over the next few years and, with the natural dilution of our shareholding through C-bond conversions over the next 12 to 24 months, this will help HLBB keep up the pace.

“In fact, we are confident [of doing] better as our strong growth engines in the SME (small and medium enterprise) business and wealth management are expanding at a rate exceeding 10% year on year. Furthermore, we see significant opportunities in Singapore, despite any potential economic headwinds.

“We are actively establishing our niche in the middle-market commercial banking segment and tapping into the international private wealth flows from entrepreneurs as we believe there is no lack of growth opportunities for HLBB, especially with the upcoming Singapore-Johor Economic Zone and our other network banking initiatives coming up,” he says.

In an interview with The Edge earlier this year, Lam had acknowledged that BoCD’s rapid earnings growth and strong contribution pose a challenge to HLBB.

“My issue is, if it is growing so fast, the rest of my business cannot keep up with it. So, I need, in a way, to ensure that we moderate its contribution and let the other parts of our business catch up. That is my big challenge, I would say. That’s why I need to get Singapore and the rest of our overseas markets to all step up. Then, we have a chance of keeping apace,” he had said.

HLBB’s stake in BoCD came into focus last week as the Chinese lender’s management had hosted an international investor event. Banking analysts from Malaysia who attended the event in Chengdu — the capital of China’s Sichuan province — came away assured that BoCD is prudently managed and has no major asset quality issues stemming from China’s property crisis. More importantly, they see it continuing to be on a strong earnings growth path.

“As BoCD will continue to benefit from robust infrastructure developments and economic growth in the Sichuan province, its growth rate is unlikely to moderate. Its contribution to HLBB will continue to rise by more than 30% as a proportion of HLBB’s FY2025-FY2027 pre-tax profit, posing a good challenge,” Affin Hwang says in its report.

BoCD’s net profit has expanded at a compound annual growth rate of 20% in the five years from FY2018 to FY2023, far outpacing the five-year net profit CAGR of just 6% for HLBB excluding BoCD, Maybank Investment Bank Research notes.

“[HLBB’s] management does not rule out reducing its stake in the long run to about 15%. Even so, with two board seats on BoCD, management believes it would still be able to equity account for BoCD’s earnings with a 15% stake,” the research house says in a Sept 9 report, noting also the natural dilution in the stake to 17.8% once BoCD’s other shareholders convert their C-bonds.

HLBB had in July 2008 acquired a 19.99% stake in BoCD for RM877.5 million, which was later diluted to 18% after the latter was listed on the Shanghai Stock Exchange on Jan 31, 2018. After converting the C-bonds in 2022, its stake moved back up to 19.8%.

Bloomberg data shows that all 16 research houses that track HLBB have a “buy” recommendation on the stock, with the average target price at RM24.72. As at Sept 13, the stock had gained 13.6% year to date (YTD) to close at RM21.20, for a market capitalisation of about RM46 billion. Its YTD gains are among the lowest of the 10 banking groups listed on Bursa Malaysia.

“We believe HLBB is underappreciated for its overall strong book value accretion of at least RM1.30 to RM1.60 per share per year from FY2025 to FY2027, with no major risk to book value given latest reassurance on BoCD,” says CIMB Securities, which cites HLBB as its top pick in the banking sector. 

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