HSBC: After the Deluge

By Robert Sutherland Smith

The one thing that I have always liked about HSBC (HSBA) was the legacy of those old Scottish colonialists for hard headedness and Church of Scotland respectability. Tea planting and banking were two well known commercial pursuits of Scots imperialists. But here we are with HSBC caught out by the tax avoiding activities of a Swiss banking subsidiary which HSBC acquired, I understand, along with its one time US parent bank. Not something a Minister of the Kirk would find desirable. That, along with some poor results for last year, has reduced the HSBC share price to 576p – the lowest it has been since 2012 and well below the 750p plus it reached in 2013. The share price looks possibly oversold to me. But is it?

The first cause for concern and consideration has to be the dividend. HSBC is a dividend stock so it is a preliminary and necessary first step to get some assurance on that. The current annual dividend yield is 5.68% and that marks the shares as looking good value if its maintained and progressed. Even on last year’s results, as poor as they were, the annual dividend is covered by earnings in dollar terms; an annual dividend of $0.50, covered by reported earnings of $0.69. (Remember the company does its accounting and reporting in US dollars.) The cash flow position looks less reassuring on the basis of the annual 2014 cash flow figure. They tell us that there was a cash outflow of $21.4 billion in contrast with an operating cash inflow of $44 billion the year before. Thus, last year the dividend costing $6.6 billion was not covered by operating cash flow in contrast to the position a year earlier. However, any cause for concern about future dividend payments on that basis of thinking is countered by an explicit undertaking in the report to shareholders, to grow the dividend consistent with the overall growth in profitability. 

With regards to next year, management seems to find some positive trends to tap into despite the poor profits in 2014. These it itemises as outward investment from China; further potential liberalisation of the Renminbi; the reshaping of the Chinese economy, making it less dependent on exports with more consumer spending; banking opportunities in the European Markets Union; the EEC’s focus on growth; continuing growth in the US economy; the boost to the world economy of lower oil prices; and, potentially, the fruits of the Transatlantic Trade and Investment treaty.   

The bank has also improved its common equity Tier 1 capital ratio from 10.8% last year to 10.9% with a total capital ratio of 15.6% versus 14.9%. Its management  recognise that earlier targets for capital adequacy are now unrealistic and plans are in place to proceed towards a new common equity Tier 1 ratio of between 12% and 13% with a return on equity of 10%. Last year the return on equity figure was 7.3% down from 9.3%. 

The consensus of market estimates shows forecast earnings growing from 56.5p in 2014 to 63.7p in 2016, which puts the historic price to earnings ratio at 10.7 times for 2014 and 9.5 times estimated for 2016. The annual dividend yield is estimated to increase from 5.4% for 2014 to 6.4% for 2016. To me, those are ratings which indicate good value. Furthermore, the net asset value shown as being $9.28 per share translates to 618p per share on a $1:50 sterling exchange rate, meaning that HSBC shares are selling at 7% discount to net assets. All of which causes me to conclude that these shares at this price look good value. That conclusion is reinforced by the fact that the HSBC share price has notably underperformed the UK banking and financial sector in the last 90 days as well as the FTSE100 Index over recent years – by nearly 10% over the year in fact, and a truly massive 48% over five years. These shares are very attractive in my opinion; full of bad news and discounting it.