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HSBC Holdings Summary

Core Content

HSBC Holdings is a multinational banking group with a strong presence in Asia (excluding Japan), the UK, the Middle East, and North America. The document provides an analysis of its financial performance, valuation, and investment rationale as of 2016, with a focus on earnings, dividend policy, and capital structure.

Key Financial Highlights

• PBT (Profit Before Tax):

  • Adjusted PBT for 2016E is $5.4bn, slightly above the forecast of $4.6bn due to lower costs and higher trading income.
  • PBT was cut by 1% after 1Q 16 results, but EPS forecasts fell by 3–5% due to higher tax.
  • The CET1 ratio is 11.9% (flat q/q), but is expected to rise to 13.0% by year-end due to the Brazil sale.

• Dividend Policy:

  • The dividend payout ratio is 89.4% on an underlying basis in 2016, and over 100% on reported profits.
  • The group has stepped back from its previous guidance of a 50–60% payout ratio.
  • A dividend rebasing may be necessary at year-end 2017 if earnings remain low.
  • If rates rise, the payout could remain high for another couple of years, but if conditions persist, a 80% payout is considered very high.

• Earnings and Profitability:

  • EPS for 2016E is 0.57, down from 0.60 in 2017E.
  • ROE (Return on Equity) is expected to be around 6.9% for 2017E, with a low return on tangible equity of 7.35%.
  • Pre-Provision ROA (Return on Assets) is 1.11% for 2017E.

• Valuation:

  • HSBC trades at 11x 2017E earnings, which is a typical bank multiple.
  • It trades at a 17% premium to the European bank sector.
  • The stock trades at 0.7x price to book value and 0.9x price to tangible NAV.
  • A Gordon growth model valuation suggests a price objective of 450p (GBP) and HK$51.21, based on a 7% ROE and 10% cost of equity.
  • A sum-of-parts model suggests a valuation of HK$63.2 per share, with a potential upside.

Investment Rationale

• HSBC has a strong capital position with a fully phased-in Basel 3 CET1 ratio above 12%.
• The bank is facing challenges due to:
  • Lower for longer interest rates, which are especially expensive for HSBC.
  • Increased capital requirements, which have made the business more capital-intensive.
  • The need to maintain capital buffers, leading to asset shrinkage.
• The investment case is based on the expectation of future earnings recovery and rate hikes, but the current low returns and high payout ratio raise concerns about sustainability.

Risks and Opportunities

• Upside Risks: Greater-than-expected US rate hikes and a stronger global economy.
• Downside Risks: Rate reductions, increased litigation and conduct costs, and a slowdown in China affecting the Asia region.

Key Tables

Estimates (Dec)

Valuation (Dec)

Key Balance Sheet Data

Key Income Statement Data (Dec)

Investment Opinion

• Investment Rating: Underperform
• Price Objective: 450p (GBP), HK$51.21
• Valuation per Share: £8.2 (based on sum-of-the-parts model)
• Dividend Yield: 8% (elevated compared to historical averages)

Conclusion

HSBC faces ongoing challenges due to regulatory pressures, low interest rates, and a shrinking loan book. Despite strong capitalization, its profitability and dividend sustainability are under question. The investment case is based on the expectation of future earnings recovery and rate hikes, but the current valuation and payout ratio suggest a cautious outlook. The Underperform rating reflects concerns over low returns and the potential for a dividend rebasing.