Stranded Chartered?

For Standard Chartered bank at 600p (last seen) the Sands of time run out as Winter arrives. Are things as bad as they look or is this really the bottom? 

This has been the fortnight of Asian bank reporting. We have just had the third quarter results from HSBC (HSBA) which were well received by a highly rated stock market on the lookout for lowly rated recovery shares. So will it be a similar story for Standard Chartered (STAN)?

Like HSBC, the story of Standard Chartered over the last year or so has been one of ‘hubble, bubble, toil and trouble’. The fall was greater for Standard Chartered because it had started out with a share price that stood at a handsome premium to the bank’s net equity assets, which reflected the bank’s former scarcity value for profits growth linked to the economic rise of China.

When problems came, they were made worse by the bank’s comparatively and absolutely poor communications with investors and the market  generally and its strikingly different quality of reporting – which served more to obscure than delineate – in comparison to other banks, particularly HSBC. That heightened mistrust between management and market heaping uncertainty on operating disappointment. Was the bank’s obscurantism in place to hide the facts or simply because the management did not have a sufficiently firm grip on them – or both?

Management change

Last year, the former CEO, Peter Sands, saw his reputation and influence go down with the setting sun over the bank’s immediate prospects. The resignation of Mr. Sands and the appointment of Bill Winters have marked the ending of one management era and the beginning of another. The management sentiment slate has been wiped clean.

New CEOS are generally good for the share price of the companies they come to manage in such circumstances, not merely because ill will towards their predecessor is turned into goodwill towards the succeeding CEO, but also because the incoming man can freely take actions which damage near term equity earnings prospects, because such action can be pinned on the outgoing man. That means successors have the scope to overdo their diagnosis and medicine in the expectation of enhancing the prospects, for which they themselves, will most certainly be held to account. That particular clock of accountability will start ticking for Bill Winters’ stewardship next year – the year to December 2016.

Before leaving history behind, I observe that the retiring Peter Sands had overseen some significant and beneficial work in improving things. The accounts for the year to December 31^st 2014 showed that operating cash last December 31^st had risen almost six fold, to $55.5 billion from $9.4 billion the year before.  That made a considerable contribution to the related increase of some 60% in the year-end cash to $52 billion. Moreover, the programme of change to take the bank out of capital hungry, low return businesses had begun early this year – a policy which has been continued under the new CEO Bill Winter.

The latest results

Over the nine months to 30^th September last, top line income fell nearly 12% but operating expenses also fell, by 4% from $7 billion to $6.8 billion. True to the times, regulatory costs over those nine months jumped 43% to $690 million – an amount that represented one tenth of the cost of operating the business. In the event, operating profit in the first nine months of this year tumbled 25% in comparison with the reported operating profit figure the year before.

The third quarter made a particularly emphatic contribution to the nine month total. In the three months to 30^th September, operating profit was shown as 60% down year on year; bad and doubtful debts were up by 129% that quarter. Was this a case of some really bad lending gone sour or more a case of everything being chucked into the bad debt account, including the ‘kitchen sink’ by the new executive management as a means of underwriting the absolute and relative performance at some future date, when perhaps any ultra-conservative provisioning can be brought back?

There is also the sound of ‘stable doors being bolted’ with an announcement that banking exposure to commodities had been reduced one fifth and exposure to China reduced by 15%. It is a particularly gloomy analysis and forecast that envisages a Q3 result next year being as grim and draconian as those of the last three months. Clearly, much has been done in terms of remedying exposure to damaging things and events, to shift the betting odds in favour of a comparatively better result in the third quarter of next year. Whereas bad and doubtful debts rose by the precise sounding 129% in the third quarter just reported, they rose 108% for the nine months as a whole.

New capital

The announcement of an equity funding was the fulfilment of long anticipation, which is good psychologically and good financially. The $5.1 billion dollars raised (net of expenses) improves the bank’s capital and reduces the uncertainty about whether Standard Chartered has enough capital to withstand such losses and satisfy banking regulatory requirements. We are told, specifically, that the impact of the new equity was to raise the bank’s capital ratio from 11.5% to 13.1% as at the 30^th of June 2015. Such action puts Standard Chartered at an advantage to many other banks who are struggling to improve capital ratios from cost cutting and a change in the mix of risk weighted assets etc. Standard Chartered has the benefit of more capital whilst still reforming and cutting its cost base, activities and risk weighted asset base.

Changes to the bank’s business mix

In that regard, we are told that the bank is to change the asset base to support lower capital intensive business and higher profits. That seems to mean providing fees based services for high net worth individuals and a reduction in some corporate lending, in relation to a reported one third of the bank’s total assets.

The bull case

However, there is a clear fundamental case to be made in favour of these shares at this point after a very long decline. It includes the following points:

• There are absolutely no profits to be taken in this share because it is now at its lowest point in price for five years. A long five years ago, the shares were priced at around 1,885p.
• The last June 30th balance sheet reported total assets of $695 billion, commanded by equity reported at a value of $49 billion. The latter looks to be at a considerable discount to an estimated dollar market capitalisation of the equity, which I estimate, on a 1.51 dollar / pound sterling exchange rate to be in the region of some $23 billion – on that basis, a discount of over 50%.
• As a bank that has been in business in Asia and Africa since the nineteenth century with a total asset value of a reported $695 billion, this bank has financial attractions. It is also potentially a takeover target, if in theory only – given the fact that most banks are contracting and ‘de-risking’ rather than expanding.
• The market consensus estimates a 50% fall in earnings this year to 46.4p, with  a recovery of 24% (to 54.5p) next year putting the shares on prospective estimated price to earnings ratios of 13.5 and then 11.3 making next year’s forecast cheap in estimated  PER terms in relation to estimated 2016 earnings growth in percentage terms.
• The dividend reduction fear has been addressed by the cutting of this year’s final dividend. The consensus dividend yield estimates are 3% for the year which closes at the end of next month and 3.6% for next year.  A useful income in a deflationary world.