HSBC: A Perfect Storm

by The U.K. Income Investor

HSBC (HSBA) has struggled badly since it last featured on the site at the end of April. At the time, shares in the Asian banking giant changed hands for around 425 pence apiece. I thought that represented an okay long-term deal, but the market thinks not. The shares go for just over 300 pence each at time of writing. To get a sense of how big the damage is here then just consider this: you would have to go all the way back to the mid-1990s to find the last time the stock traded in this area. Granted, a big pile of dividend cash has also been paid out in that time, but it is still an extraordinary fact.

Of course, bad news is not exactly in short supply here. Indeed, it is hard to know where to start given the bank has faced an almost perfect storm of issues. The impact of COVID-19 is probably the most obvious place to begin, with HSBC setting aside almost $7B for expected credit losses in the first half of the year. Moreover, interest rate cuts have taken a chunk out of its net interest income. The bank recored net interest income of $14.5B in 1H20, down 5% on the year-ago period. That combination has reduced net profit considerably, with profit attributable to the ordinary shareholders of the parent company clocking in at just $2B over the first half of the year. HSBC made around $8.5B over the same period last year.

Then we have the myriad of other issues. For instance, the political situation in Hong Kong and China has weighed on the bank for some time now. Despite its tag as a global bank, HSBC makes the lion’s share of its profit in Hong Kong. Pre-tax profit in the region totalled $12B last year; that was out of company-wide total of around $22B. More recently, it has faced allegations that it had facilitated the transfer of large sums of suspicious funds. These kinds of scandals seem endemic in large banks, and they do nothing to help their overall investment cases.

Valuation

Although headwinds are not hard to find here, the stock does have some things going for it. For one, the bank remains well capitalised. HSBC reported a CET1 ratio of 15% at the end of 2Q20, up 40 basis points on the end of 1Q20. That increase came on the back of retained profit generation – shareholder dividends having been suspended this year – and a drop in risk-weighted assets. As was remarked in the last piece in April, the bank remains in more conservative shape than in the last major economic downturn.

The second thing I’d highlight is the valuation. Put simply, the shares look like decent value. Granted, that does not offer much to long-suffering shareholders, but still. The bank reported a tangible book value of circa $7.34 per share at the end of the first half of the year – call it around 572 pence per share at current exchange rates. Or put another way, net assets cover the current share price here by a factor of nearly two. Unless the bank’s returns on its assets remain incredibly depressed for a long time, I’d say that is quite cheap.

HSBC was making somewhere in the $12B area in terms of annual net profit pre-pandemic. Clearly, this year looks like a write-off, with analysts expecting the bank to set aside nearly $11B for bad debt. After that, things look set to remain somewhat subdued next year, again on the back of lower net interest income and elevated levels of expected credit losses. Those analysts only really see profit recovering to anywhere near pre-pandemic levels in FY22. Even so, the implication is a forward earnings yield of circa 13% by then. If HSBC pays out 80% of profit by way of a dividend, you are looking at a 10% dividend yield. Whether that can support the share price in the short-term remains to be seen.

Note

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