HSBC looks like a cheap way to invest in Asia – should you buy?

HSBC has refocused its business towards Asia, and China in particular. If it can increase earnings, the bank looks cheap, says Rupert Hargreaves. So should you buy HSBC shares?

As it retreated from markets in the Americas and Europe, HSBC (LSE: HSBA) formally dropped its “world’s local bank” tagline in 2016.

Despite its global ambitions, Hong Kong has always been HSBC’s main market, with around 90% of group profits historically coming from its Asian business. And in recent years management has doubled down on China, shifting $100bn of capital to the region as the bank has exited other regions.

HSBC’s focus on China is producing mixed results

The results of the group’s new strategy have been slow to materialise. Revenues have stagnated over the past six years, and profits have been unpredictable. As an investment, the stock has been dead money since 2017 (even after adding in dividends). It has lagged the market by half over the past decade.

Most of these challenges are a direct result of the firm’s new strategy. Sales have come under pressure as it exits markets, while the costs of the restructuring have eaten into profitability. That’s without considering the twin headwinds of economic uncertainty and ultra-low interest rates.

With interest rates on the up, HSBC’s outlook is beginning to improve. What’s more, even though economic certainty remains, it is in a far better position today to cope with volatility and instability than it was in 2018-2019.

Notably, the company has made significant progress cutting costs and has redoubled its efforts to reduce spending in the second half 2020. It is now beginning to reap the rewards. As other organisations struggle to offset rising wage pressure with higher prices, HSBC is expecting costs to remain flat this year as it cuts a further $2bn from operating spending.

In the first quarter, reported operating expenses declined by 3% as “continued growth in technology investment” offset inflationary pressures.

Lending growth continues to boost profits

Keeping a lid on costs will help HSBC outperform in a tough market. It has already increased its provision for bad loans in the year. It reported a profit before tax of $4.2bn for the first quarter, down $1.6bn due to “a net charge for expected credit losses and other credit impairment charges” as well as the costs of exiting the Russian market.

HSBC also reported a 4% decline in reported revenue to $12.5bn. Less capital market activity hit trading revenues at its investment bank, offsetting lending growth.

Still, lending is a bright spot for the firm. Consumer lending balances expanded to a net $9bn and net interest income increased in all global businesses. The bank’s net interest margin – the difference between the rate of interest the group pays to depositors and charges to borrowers – increased by 0.05% to 1.26% in the first quarter as overall lending income rose by 7.7% year-on-year.

The loan book is where HSBC has the potential to generate real growth over the next couple of years. With a common equity tier 1 ('CET1') capital ratio of 14.1% at the end of the first quarter, and an estimated $700bn in surplus deposits, it has the capital to grow lending volumes.

Investment banking can be a very profitable business, but it is also volatile, requires a lot of balance sheet capital and is very relationship driven. Well-connected (and well paid) bankers are needed to keep clients sweet.

The investment bank is an important part of HSBC’s business strategy, but lending to consumers and businesses is far more stable and predictable. These divisions also require less balance sheet capital and lending decisions can be executed (and serviced) by technology. The fees on a 25-year mortgage might pale in comparison to a $25bn merger, but the lender can process thousands of these lending decisions every hour using technology to reduce costs. This volume and the predictable interest income makes up for the smaller up-front fee.

HSBC is expecting a mid-single-digit percentage increase in overall lending growth this year, due to a combination of higher interest rates and more lending. Management also believes fees from its wealth management business will also recover when pandemic restrictions are lifted in Hong Kong.

If the bank can boost earnings, HSBC shares could be cheap

After half-a-decade of change and development, HSBC has a lot of scope to grow over the next few years. That said, economic uncertainty is already having an effect on profits, and with the outlook for the global economy only deteriorating, I would not rule out further negative developments.

Still, with the shares trading at a price/book (p/b) value of 0.7 and forward price/earnings (p/e) multiple of 9.9, HSBC looks cheap if it can continue to grow over the next few years. Its dividend yield sweetens the appeal. Analyst projections also have the stock yielding 4.3% this year, although management is warning that further share buybacks are unlikely as uncertainty persists.

Considering its valuation, the company could be a cheap way for investors to play the growth of the Chinese economy and rising interest rates. However, as uncertainty builds, some investors might prefer to seek protection elsewhere.

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