Monday, 23 February 2015

Why I just bought some HSBC

Not a happy results day for HSBC with the shares down just under 5% at the time of writing at around 575p or – to put it another way – putting the shares at a two-and-a-half year low:

So why was this?  Well profits well flattish on an underlying basis…but there were significant FX and ‘significant items’:

Regulatory factors continued to impact but just as influential on Q4 per was the wonderful catch-all of ‘other operating expenses’ (‘inflation and investment to support staff in Asia’).  Funding fair value adjustments (FFVA) on uncollaterised derivative contracts also lagged as did loan impairments (more of the latter below).  Not a great combination.  

All of this overhung the return on equity generation which led to a pullback in the company’s forward-looking RoE target:

Geographically and divisionally there were some clear trends with the ‘markets’ business lagging but credit/lending better in both the retail and commercial businesses. 

Geographically the above revenue trends played our net strongly in Asia and negatively (due to write-downs) in Latam.  Divisionally profitability terms on the commercial side but the global markets business struggled. 

This bump in Latam loan impairments is best shown here.  In absolute terms these numbers were relatively minor but negatively contributed along with all the other factors. 

On the conference call the company talked about being well-positioned for ongoing trade flow growth and structural positives…which basically boils down to 78% of the profitability this year coming from Asia (where they grew by c. 8% in FY14).

(h/t for this @ScouseView)

Bottom line whilst HSBC remains prudent from a loan/asset perspective (72%) it has traded every more dully from a returns perspective despite continuing to build up its tier 1 ratio (which looks quite prudent):

If you believe the company is going to get to a 10% RoE then the share today at x0.86 price:book is good value (fairer value today nearer 670p)…however baked into this is the sub-target of having a 2018 cost base akin to 2014 despite regulatory/inherent wage inflation. 

The company note over the last few years they have achieved c. US$1.5bn pa of savings ‘which have been invested back into the business’ and the differential is not that they will not be able to continue achieving such savings but that they would have ‘greater regulatory clarity’. 

Noted too continuing run-off returns enhancing possibilities and across all divisions the capability to cut costs/improve returns hence if latter not possible ‘perfectly reasonable to assume this management team will exit these businesses’. 

They also noted that there are top executive global calls on ‘four businesses: Mexico, Brazil, US and Turkey’ on efforts to turn these around and that ‘there are no options on this turnaround (including selling them) that they would not consider over the next 12-24 months’. 

Some surprisingly firm announcements.  Quite right too given that the Hang Seng bank business generates c. 16% RoE with 40% odd of the capital base.  As management acknowledged this meant that the rest of the business generated a pretty negligible return. 

They see little scope for further net interest margin negative surprises.  

So the 6% current dividend?  They talk about a ‘progressive dividend’ and this looks to be true just about on the evidence so far. 

HSBC remains a value investment but I was heartened by some of the cost cutting/potential business exit tone by the management.  Of course this partially reflects the pressure now the executive team are under (clearly accentuated by the lurid headlines out there about the private banking disclosure aspects). 

I would not sell here.  Clearly there is exposure to the ongoing China story (as shown by the Hang Seng bank RoE comment or Asia profit split above) but I think the scope for a HSBC reshaping surprise (business exits, further cost cutting) exists.  This would also help further support the dividend and close the value to book.  For value buyers this is a day/level more to buy than sell.  I would augment a purchase sub 575p here with another at 525p and a final one below 500p.  

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