Response to Comment on the Analysis of Chinese Banks

Thanks for the comment of an anonymous reader in my blog "Analysis of Chinese Banks Listed in Hong Kong".

The analysis of this blog is a general discussion of the banking industry of China. Agreed that more in-depth discussions needed for better understanding of those Chinese banks.
The reform of Chinese banks has just been started for several years and the historical data for a thorough analysis may not be enough. However, analysis should be based on historical data such that we have a better ground in predicting the future development. CCB had its IPO in Oct 2004 for which its performance in 2005 has mostly truly reflected the actual performance of this bank. I don't agree that the figures are solely for higher IPO valuation.

In the short run, the stock price can be affected by certain reasons such as the market atmosphere, demand and supply of stock during the time period etc. BoComm receives higher multiples in the stock market may be due to the following reasons :
1. HSBC as a strategic investor of BoComm has hold nearly 20% of its stock for which the supply in the market is more limited.
2. HK investors are very familiar with HSBC and trusted its management ability in partnering BoComm but not solely for BoComm's own management.
3. Beliefs that smaller companies may generate better growth in future.
However, the stock price in long run should reflect the effeciency and profitability of a company. 1~2 year does not mean too much in investment. Large size companies in banking industry in the long run should be able to outperform smaller size ones as banking is a capital intensive industry. Of course we need to make sure that the bank is well managed. CCB also has a strategic partner of Bank of America and BOA has also sent a team of personnel to CCB to help to improve their management but this is seldom mentioned by the media. Therefore, I believe that CCB will be able to improve their management to achieve better success.

NPL provision coverage is a good idea to be investigated. The NPL of Chinese banks has now been amplified by the market for which has become the major concern of investors. However, if you believe that the economy of China will continue with its rapid growth, NPL should not be a major barrier in investing in Chinese banks. In contrast, this provides a better opportunity for you to buy their stocks at cheaper price.

Economic Franchise

Economic Franchise is an important concept of value investing. A well managed company in a commodity business may not be able to sustain its growth in the long run but an average company with economic franchise can be with good performance for a long period of time. This shows how important economic franchise to a company. There are three characteristics of economic franchise :

1. The product or service are highly needed by its customers.
2. Customers can not find a similar product or replacement easily.
3. Customers of the product or service are not too price concerned.

Companies with economic franchise are more likely to sustain their growth in the long run and their performances in the future are easier to be predicted. Economic franchise can be in different ways of appearances such as branding (Coca-Cola, WD-40), state protected market dominance (Petro China) or market dominance through market (Towngas in Hong Kong) etc.

Branding :
Coca-Cola is a well known brand in soft drinks market throughout the world. Its brand is so well established that even you have got its secret formula, you cannot establish an enterprise with similar performance as Coca-Cola. This is because its brand has been successfully promoted with a representation of modern, tasty and in line with the American/Western culture image.

State protected market dominance
Petroleum is a strategic industry in China and China government will only allow pre-approved enterprise to do business within this area. Petro China is the largest state owned enterprise allowed to do the oil business in China. They can easily dominate the China oil market and turn economic franchise into huge profits.

Market dominance through market
Towngas in Hong Kong has the market dominance in Hong Kong through its management excellence. As an important element in Chinese cooking behavior, towngas have outperform major competitions from petroleum gas and electricity through their well established supply network and excellent service. Their economic franchise is granted by the market ie customers.

In general, market dominance granted by the market is more likely to sustain than state protected as the market not government is the ultimate profit origin in a free market.