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 425p apiece. I thought that represented an okay long-term deal, but the market thinks not. The shares trade for just over 300p 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. It is actually hard to know where to start given the bank has faced an almost perfect storm of issues. Let’s go with the COVID impact – 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 (“NII”). The bank recored NII 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 for the first half of the year. HSBC made around $8.5b in 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 out of a 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.
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 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. The bank remains in much more conservative shape than in the last major economic downturn.
The second thing I would highlight is the valuation. Put simply, the shares look like decent value. 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 572p per share at current exchange rates. That means net assets cover the current share price by a factor of nearly two. Unless the bank’s returns on its assets remain incredibly depressed for a long time, I would say that is unduly cheap. That does not offer much to long-suffering shareholders, but the point stands nonetheless.
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 NII 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.
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