HSBC’s Asian growth story offers a tonic to European risks

The European banking sector made gains earlier this week following the first round of the French election. Investors seem to be upbeat about the prospects for pro-European candidate Emmanuel Macron. If he wins in the second round against Marine Le Pen, the consensus among investors seems to be that the EU and the Euro could live to fight another day.

Whatever happens with that election, the UK’s election and Brexit, political risk in Europe is likely to be high for a long while. Even if both elections produce winners who are seen as more conducive to growth in Europe, the outcome of Brexit is likely to remain highly uncertain for the full two-year negotiation period. Then, when the UK finally goes it alone, nobody knows how it will cope and how favourably it will be seen by foreign investors.

This risk is a key reason why I think looking outside of Europe for growth is a sound strategic move. HSBC (LON:HSBA) derived 74% of its adjusted pre-tax profit from Asia in 2016, reports in US dollars and is therefore far less susceptible to weakness in Europe. Given its growth potential and valuation, now could be the perfect time to buy it.

European risks

Perhaps the most surprising aspect of the rally earlier this week is that it is incredibly short-termist. Although it now appears more likely than previously thought that a pro-EU candidate will become the French President, there is still a long way to go until that point. Therefore, just as was seen in elections/referendums in the last few years, investors are already pricing in the favourable outcome when in my view they should be thinking further down the line.


The main reason for this is the fact that even if the French election goes as expected, attention could swiftly turn to the UK election. While there has been little change in polling reports, with the Conservatives still well ahead, polls can be vastly wrong. Therefore, both the French election and the UK general election could cause more uncertainty not only prior to their results, but also regarding their outcomes if they do not end up with the more likely result.

Even if they do, Europe potentially faces many months of risks. Although a loose monetary policy could offset the effects of higher political risks to some extent, the region faces two years of Brexit negotiations. They could lead to heightened uncertainty and lower investment in the region. Therefore, in my opinion it may be prudent to pivot East and focus on growth prospects in Asia.

Relative opportunity

While the Asian growth story has been around for years, it is changing. Gone are the days when mining stocks were the best play on Asian growth. Today, it is consumer stocks, and particularly financial services companies such as HSBC. Not only does HSBC have a comparable exposure to the Asian economy in terms of its proportion of profit derived from there, but it also offers a much lower valuation than consumer goods peers.

Not only does HSBC have a comparable exposure to the Asian economy in terms of its proportion of profit derived from there, but it also offers a much lower valuation than consumer goods peers.

For example, HSBC has a prospective P/E of 13.3, while Unilever, Diageo and Reckitt Benckiser have prospective P/Es of 22.3, 21.5 and 21.7. Certainly, consumer goods companies may have greater brand loyalty and more stable earnings outlooks, but HSBC could deliver a successful turnaround following ballooning operating costs. This could act as a significant catalyst on its share price.

In response to operating costs hitting a record levels, the bank has decided to implement major headcount reductions and other cost-saving measures which are designed to save $6 billion in annualised operating costs by the end of 2017. To do so, the bank plans to invest around the same amount by the same date. This should help to reduce its cost:income ratio from 2016’s bloated 60.9% level, which was already down marginally from 2015’s 61.7%.

Consumer potential

As well as the potential for cost reduction, HSBC’s profitability is likely to be pushed higher by growing sales which will result from rising wealth and demographic changes in Asia. For instance, the Asian economy is expected to grow threefold between now and 2050, Similarly, the proportion of middle class people in the global economy is forecast to increase from one-third to two-thirds by 2030, propelled higher by the rise of the Asian middle class.


With HSBC increasing the size of its loan book in China, growing assets under management in Asia by 11% versus 2015 levels and increasing insurance manufacturing new business premiums in Asia by 13% in 2016, it seems to be making strong progress in the region which could continue into the future.

Specifically in the continent’s largest economy, China, incomes are forecast to rise 46% between now and 2020. In an economy in which individuals are become increasingly consumer-focused, requirements for retail banking services and credit services could increase in line with rising wealth levels. This would lead to a tailwind for HSBC’s operating performance in the long run.

Outlook

Since HSBC reports in US dollars and generates the vast majority of its profit from Asia, its exposure to Europe is relatively small and in decline. In the next few years, I expect its focus on Europe to continue to shift Eastwards, since the opportunities for growth are higher than in Europe and the political risks could prove to be lower.

Even if the two upcoming elections and Brexit talks progress smoothly, I believe investing in HSBC could yield higher returns than local European indices. It offers a relatively low valuation, the potential for higher profitability resulting from its efficiency drive, as well as significant growth potential from increasing wealth across the Asian economy.

Therefore, while the Asian growth story is not particularly new, it continues to offer relative appeal at a time when the European economy faces uncertainty. Given the relatively high valuations of consumer goods companies and the opportunities within retail banking in the region, I believe HSBC could be a sound means of accessing the continent’s growing, transitioning economy.  While unlikely to be frictionless, it could prove to be a tonic for European uncertainty and the region’s potential challenges over the medium term.