HBCYF - A Fresh Take On HSBC Heading Into 2024: The Big Bank Continues To Make For An Attractive Investment Case

2023-12-15 12:37:03 ET

Summary

• HSBC has had a successful year with strategic moves in India and China, leading to a rise in stock value.
• The dividend yield has consistently increased, with HSBC having the highest dividend yield among its peers at 5.07%.
• HSBC's total returns have been impressive, outperforming the S&P 500 and showing potential for future growth.
• The capital position of the bank appears sound and better than its closest rivals, which should boost investor confidence.
• There is enough evidence to suggest that HSBC is undervalued in comparison to its peers.

Investors have plenty of reasons to buy shares of HSBC (HSBC). The global banking giant has had a pretty nice 2023. Up 25.32% YTD , HSBC has focused on Asia expansion , with some strategic moves/acquisitions in India and China. This may have given the stock impetus this year. Additionally, the firm's revenue strength has been quite remarkable. Value and dividend-conscious investors will be pleased to see that the dividend yield has kept consistently rising.

HSBC appears to have started paying its dividend in 1999, with consistent increases every year since then and now has the highest dividend yield of the peer group at 5.07%.

We can be considered HSBC veterans as we have looked at it twice before. And why not, the stock has outperformed the S&P 500 since our last coverage and has not been apparently troubled by the mini banking crisis we had in April.

The stock has a considerably higher yield and has been trading at lower multiples than its biggest peers Wells Fargo & Company ( WFC ) and Royal Bank of Canada ( RY ). HSBC has clearly turned the corner. We say this for the simple reason that HSBC total returns have been an impressive 24% YTD. While in the past, HSBC has comparatively been an underperformer for shareholders, this may change in the future. We can point to the total annual return over 10 years which stands at about 1.64% for HSBC . This is a far cry from the 8.5% computed for Royal Bank of Canada. The ten-year WFC average annual return has been 2.60% with dividends reinvested. Again, we should mention here that the return on average ordinary shareholders' equity at HSBC was 8.7% in 2022, the highest return since 2013. There is a lot of hope.

HSBC has committed to manage capital efficiently , with excess capital being returned to shareholders when deemed appropriate. HSBC management hoped to maintain the CET1 ratio within the medium-term target range of 14% to 14.5%. Even though this is 0.4 points below the current level, it is still a highly respectable value especially when you compare with the peers that I mentioned in the previous paragraph.

The bank has done well with regards to the liquidity coverage ratio which comes in at 132%, higher than the aforementioned peers. As of Q2 2023, Wells Fargo had this ratio at 123%. For RBC , the ratio has hovered around 130%. Even as HSBC is ahead, we must point out that this LCR has been higher at 139% in the last couple of financial years.

The net stable funding ratio also looks sound for HSBC at 136%. For RBC, the figure is 112% and on the decline. As for Wells Fargo, the last annual report did not overtly mention the NSFR percentage. It did, however, say that the bank complied with the funding requirements. It may be safe to say that HSBC leads the pack on this front too.

The deposit growth has been 4% each year since 2019. This is quite a healthy trend.

Contrary to popular belief , the company has been prudent in its lending activities as of late. There have been significant decreases in allowances (ACLs) and especially provisions (PCLs) for credit losses, which dropped to $1.9 billion in FY 2022, about $0.6 billion lower compared to the prior year.

The bank’s credit performance must be commended in light of the inflationary pressures. A glance at the 3Q 2023 earnings release revealed that delinquencies and write-offs remaining broadly stable.

Because PCLs have stayed relatively flat over the last couple of years, it may have helped boost earnings.

The Personal Banking unit drove the revenue in the last earnings release with net interest income generating about 20% of this. HSBC UK is the main driver of profits accounting for 22% followed by Asia, Mexico and the U.S.

Total earnings have risen by as much as 40% to $16.2 billion. It is nice to see that HSBC UK has performed so well with positive YOY earnings growth. There should be a lot more progress in this part of the world with CNBC suggesting that the next six months could be a good time to get in on the UK property ladder . Mortgages may go up most likely with the Bank of England possibly keeping interest rates as is. One could say that the Silicon Valley Bank UK purchase may be helping HSBC’s results.

The company’s Asian operations have grown immensely as well with an 8% surge in fee income, particularly in cards and payments. HSBC is expected to grow earnings in Asia through its wealth management segment. The environment looks ripe with UHNWIs on the ascent in the continent .

A closer look at the UK housing market

The UK’s house price to income ratio has dropped off. At the same time, landlords are having a bit of a rough time in the country. The trend of higher rents has made many consider buying a home for the first time. But all has not been rosy for HSBC’s lending business as mortgage defaults have accelerated and this uptick is the highest recorded since 2009. There have been quite a few banks reporting losses because of the missed mortgage payments. Still, we feel that HSBC is best equipped to navigate this rather challenging environment which has its own prospects. This is because of its strong balance sheet which will help the bank to go after opportunities as they present themselves. It must be kept in mind that the bank has a broad deposit base too; something we pointed out in our previous analysis that would help the bank to overcome challenges.

As far as the affordability of housing for youth goes, government statistics have shown that 25 to 34-year-olds who own property has gone up for the first time in 10 years. Millennial homeownerships have been a little disturbing the world over, but this has changed in recent times in the UK. This is a very encouraging sign and signifies that the economy is recovering.

How is the Chinese economy doing?

There has been some recovery observed in the Chinese economy. The troubling thing is that the weakness in the property market continues to persist. The Belt and Road Initiative, which entered its second decade in mid-October, may be the saving grace for China. The demand for infrastructure spending, rise in autocracies and urbanization has made the BRI a go-to project. Italy has pulled out of the initiative, but this will not deter Beijing which argues against undermining its hopeful ventures.

HSBC still a buy

HSBC's future results have been priced in we believe. What we're trying to say is that the economic uncertainty in the UK and the Chinese real estate exposure highlighted in the reports (both annual and quarterly), may be already in the minds of investors. If PCLs continue to stay this way and the interest rises continue, it bodes well for HSBC.

Management has worked hard to keep improve the liquidity position of the bank. In terms of the Chinese commercial real estate exposure, it currently stands at $13.6 billion . This figure is $600 million lower than in the second quarter. Given that the big bank’s market cap is $147 billion, this brings down the risks associated with the property market in China.

TBV Multiples and Loan/Deposit Ratio

A short rehash of TBV multiples and the like that we looked at before follows.

The TBV multiples are getting better with the tangible book value per share clocking in at $47.40, which is higher than what we found in the earlier article. But the price to tangible book ratio has slightly increased to 0.84. As we observed before, HSBC has done a good job in keeping the metric low and with less variance.

The loan-to-deposit ratio has been on the decline, coming in at 58.9% in the last annual report. Loan growth has dropped among European banks this year amid an overall weakening housing market and higher interest rates. Deposits have also gone down in the EU.

Valuation

HSBC is a mostly A rated company with a sustainable dividend (payout ratio of 36%). We therefore recommend it for investors constructing an income-oriented portfolio. The dividend yield may go up to as much as 10% as indicated by a nice graphic by Tudor Invest Holdings on Seeking Alpha. Additionally, the stock now trades at a very inexpensive 6x earnings. But one could make the argument that EPS may have peaked. Still, HSBC remains cheap relative to peers, with WFC at 8.8x earnings and RY at 10.8x earnings.

The lower demand for loans in the next year makes earnings growth tough, but this could change sometime in 2024. Moreover, wealth management in Asia should boost earnings in a couple of years or so. There is a very good chance that there could be even more acceleration in growth given the positive results in the recent past. If you were to look at the banking environment, analysts expect the economy to slow next year. Also, interest rates could decrease. Yet, the consensus is for this fleeting backdrop to shift gear in 2025.

There should be reasonable EPS growth even as it appears to have peaked. The P/E has historically averaged out at about 9x if were to exclude the extreme outliers recorded in 2016-2017. There is definite upside potential, and it could be in the ballpark of 10-15%. We think the stock could get close to $45 per share given all the optimism.

Banks are going to perform well and five years from now, HSBC may be poised to deliver even more earnings growth. This translates to more capital gains for shareholders who are well rewarded as it is given the high dividend that HSBC pays.

In conclusion, we believe that HSBC now more than ever is a strong buy at the current price of $39.64 per share.

For further details see: