China brokers undervalued vs US peers; expect gap to narrow driven by favorable policy, liquidity support and structural ROE expansion. Policymakers have committed to revitalising the capital market since the Politburo's meeting in July. Key initiatives taken include cutting the stamp duty for equity trading by half, enabling higher market leverage, and promoting long-term funds to raise equity allocation. Despite these concerted efforts, the anticipated benefits have yet to materialise as the equity investing sentiment has remained lackluster, primarily influenced by the prevailing uncertain macro outlook.
While the fade of initial enthusiasm led to significant correction of the sector from the peak in August, we think that presents an opportune entry point for investors, considering (1) the more attractive risk-reward profile, (2) further signs of bottoming out from macro indicators, and (3) the more concrete effort implemented from policymakers.
In particular, the recent relaxation of capital leverage ratio is expected to enhance capital utilisation of top-tier brokers, leading to a medium-term return on equity (ROE) expansion and narrowing the gap vs foreign peers. We favour China brokers over their US peers, considering (1) the multi-year growth opportunities from policy support, (2) more favorable liquidity conditions under lower interest rates, and (3) significantly cheaper sector valuations.
A new chapter for Chinese online brokers; global expansion as next key growth driver. The rectification process for online brokers since early this year has largely come to an end, as signalled by the Chinese regulators’ on-site acceptance of Up Fintech’s final remediation report in mid-July. It is also encouraging to see (1) strong retention of existing customers as per the robust net asset inflows recorded in 1H23, and (2) room to capture overseas Chinese clients, as the regulator clarified that PRC citizens living or working overseas remain eligible to be served by offshore-licensed brokers. Those with stronger profitability also seized the quieter window to broaden their geographical exposure while smaller peers struggle, putting themselves in a better position to capture a potential market rebound.
Challenging macro backdrop for global diversified financials. Many global brokers and asset managers find themselves at a disadvantage in the current higher-for-longer interest rate environment. They grapple with challenges such as diminished inflows in AUM, a shift towards money market funds, dealmaking slump, and reduced equity trading income.
Seek players with more diversified business mix and stronger balance sheets. In this environment, we believe players with a more diversified business mix and stronger capital strength are better positioned to outperform. The smoother earnings volatility should help them navigate the rapidly evolving landscape, and the stronger balance sheet should enable them to seize potential M&A opportunities and further consolidating market share, especially if there is a dip in asset valuations.
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