HSBC Holdings shares at 614p. After the tablets are brought down from the mountain, look good value on fundamentals even if the share price does seem to have run out of momentum at the moment.
Yesterday first thing, the CEO of HSBC Holdings came down from the mountain carrying in the style of Moses, new commandments by, from and to its board of directors and the calf of gold worshipping investors beyond. It was also a reminder to the market, what HSBC Holdings represents and what its longer term opportunities are in relation to that identity.
First then, we are reminded that basically, to quote word for word “HSBC has an unrivalled global position: access to high growth markets; a diversified universal banking model with strong funding and a low risk profile; and strong internal capital generation with industry leading dividends.” All of which is true. It believes that HSBC should play to its strengths and change along with a changing world.
The fundamental first commandment is to reduce the Group’s risk weighted assets (that is to say those assets which need to provide enough costly equity in the balance sheet to keep regulators happy). Although HSBC has always enjoyed a justified reputation as a well capitalised bank, which had no need to go cap in hand to the UK government and bank regulators in 2007 for bail out capital in order survive.
Nothing is settled hard fact when it comes to judging how much capital banks should have. Some have even seriously suggested that 16% is an appropriate figure. Academics and regulators argue and worry about that endlessly. HSBC is a bank that has always been ahead of the curve when it comes to capital adequacy. It looks as though it wants to keep it that way and not get left behind.
Some critics argue that the very idea of measuring the risk of certain banking activities in contrast to others, is about as absurd and theoretical as measuring the number of angels dancing on the head of some imaginary medieval pin – and subject to wishful thinking as well. Some argue for a common sense, balance sheet leverage model, which prescribes a big chunk of capital and liquid assets to secure the entire balance sheet; others urge that regulators think of a conservative number and then double for sake of doubt. The enemy of equity returns is the cost of capital. So diluting that with a bit more cheap debt is a constant temptation.
HSBC has decided that cutting out some riskier and non core assets will, if done sufficiently drastically, reduce the cost of banking and increase the return on equity. The management have targeted a future 10% return on equity in contrast to last year’s achieved 7% return. That implies a 42% improvement in earnings, if and when it occurs.
The following commandments are to sell the operations in Turkey and the non corporate banking activities in Brazil; rebuild the profitability in the North American Free Trade Area (it retains a much criticised US banking operation); take the UK deposit taking and lending operations and “ring fence” them under the old name of Midland Bank operating out of Birmingham; spend between $4 to $4.5 billion to secure annual saving of up to $5 billion beginning sometime in 2016; build revenue growth at rate exceeding relevant GDP growth; invest in asset management and insurance opportunities Pearl River Delta Guangdong; and come to a conclusion about where the Group headquarters should be located by the end of this year.
So should one buy the shares now? The chart looks pretty relaxed after the meetings with institutions and brokers. That may be market related or a result of the fact there is not great need to rush for the shares. Certainly, the proposals look coherent and credible. If an implied 40% plus increase in earnings can be achieved, that looks like a couple of years of good earnings and dividend growth. Given that the current consensus estimates are for a 19% increase in earnings this year, to a forward estimated 54p of earnings (a PER of 11.3 and a PEG of 0.6) and an estimated dividend yield of 5.4%, these shares look good value already. What is more, at 614p (last seen) the share price stands at a useful 3% discount to the last balance sheet net asset value. Technically the share price looks a bit directionless in my opinion but the fundamentals look very positive. I rate them as good value at the current price.