HSBC: Update to Fair Value after First Quarter Earnings (HSBC)

investment thesis

Our long line of buying positions on HSBC (HBSC) has paid off recently. The last buy call was in our November 17th article titled “The Interest From Above”. interest rates however The share price remains the same“.

Although the stock wasn’t going anywhere by November of last year, it’s certainly been doing well since then. The share price has increased by 34% and the total return is 40%, which is not bad in half a year.

Let’s take a look at HSBC’s performance in the first quarter of this year and their future prospects.

Is it still a buy or do we need to review our stance?

Financial results for the first quarter 2023

On the top line, a fixed currency return It increased by 36% from $14.8 billion to $20.2 billion qoq.

When we look at reported net profit attributable to shareholders in the first quarter, it came in at $10.33 billion, which was 136% higher compared to the $4.38 billion reported in the fourth quarter last year.

The large difference comes mainly from a reversal of an earlier $2.1 billion decline related to the bank’s planned sale of its retail banking operations in France. It is now uncertain whether this deal will go through. In addition, it also included a temporary gain of $1.5 billion from the acquisition of Silicon Valley Bank UK Limited in March 2023.

Net fees were stable, but net income from financial instruments held for trading, or managed on a fair value basis, saw a significant jump of 52% from $2.7 billion to $4.1 billion.

Net interest rate income was also stable on a quarterly basis at $9 billion. The NIM rose just 1 basis point, at 1.69%. That’s significantly lower than smaller DBS Group (OTCPK: DBSDY), which had an NIM of 2.12% in the first quarter. We are of the opinion that DBS’s NIM may not be sustainable, while HSBC’s NIM is likely to remain close to the current level.

When we face any economic setbacks like what we are seeing now, we always worry about the quality of the bank’s loan book. HSBC’s expected credit losses and other credit impairment charges were $0.4 billion in the first quarter, reflecting the bank’s view that it sees a more favorable business environment and a change in the weighting of the economic scenarios.

To ensure that HSBC does not suffer the same fate as Silicon Valley Bank, we want to see that the bank has a sufficiently high percentage of common equity Tier 1 capital.

As of the end of the first quarter, HSBC had a CET-1 ratio of 14.7%. That was 0.5% higher than the prior quarter, driven mostly by net capital generation from the accrual of the dividend, and included an impact of about 25 basis points from an impairment reversal on the planned sale of France’s retail banking operations.

Constant currency operating expenses in the first quarter of 2023, excluding outstanding items, were $7.53 billion, which is slightly down from the $7.80 billion in the fourth quarter of last year. As such, higher revenues and lower operating expenses bode well for controlling revenue costs.

In the past, we’ve had some concerns about their ability to control costs. Previous management mentioned JAWS, which is the difference between revenue growth and cost growth. Ideally, you want to get a raise, but it’s hard.

We were pleased in November last year when we saw a positive trend moving in the right direction.

Because costs can be lumpy and vary from quarter to quarter, we need to look at JAWS on a year-over-year basis. Here is an update on JAWS from HSBC;

The trend is positive, but JAWS is still negative. Ideally, we should see positive JAWS, meaning revenue growth is higher than growth in costs.

Return of capital to shareholders

This has been a hot topic for the bank over the past few quarters.

One of its largest shareholders, Ping An Insurance Group of China (OTCPK: PNGAY), is known to have tried to persuade HSBC to spin off their Asia business from the rest. The reason is simply that about 70% of profits come from Hong Kong, and it was the Bank of England that forced HSBC, which is based there, to halt dividend payments during the pandemic.

This split isn’t going to happen anytime soon. Ping An Insurance also wanted HSBC to distribute more dividends, and they weren’t alone in asking for it.

Under this pressure, HSBC’s board of directors has agreed to restart quarterly dividend payments from 2023 and have plans to increase the payout ratio from 40% to 50% in 2023 and 2024 from its Canadian retail banking unit, which is now expected to be completed in The first quarter of 2024.

This is the date of the dividend and our projection of the balance for the year.

Keep in mind that ADR trading on the New York Stock Exchange consists of 5 common stocks.

The increase in the dividend, which based on our forecast will be about 7%, and based on our average rate will give us a yield of 7.7% in 2023.

Further, the Board of Directors authorized the management to buy back shares worth up to $2 billion.

What we don’t understand is the timing of these buybacks. Over the past year, the stock traded between HK$40 and HK$50 below, but the management at that time did not want to do any share buybacks.

Let’s see if the stock price can return to its glory days, before the 2008 GFC:

Business prospects and risks for the thesis

HSBC is now more focused than it was in the past and is implementing various moves that will improve return on equity and overall profitability.

As usual, we like to look at a company’s return on equity as a proxy for how profitable it is and how well its capital is allocated. We indicated earlier that return on equity, which was 9.9% in 2022, was low.

With return on equity up 19.3% in the first quarter, their target of at least 12% for 2023 should be within reach.

As with other business ventures, as long as they provide excellent services and a good value proposition to their clients, more business will come their way. In the past, they didn’t have a particularly good reputation as being the best bank when it comes to customer service and value proposition.

According to an article published in March last year in Retail Banker International magazine, HSBC came in as the 11th best bank in terms of being a bank that customers recommend to their friends.

In Hong Kong, they may have a better standing, although we don’t see any similar research being done on customer satisfaction. A recent study by Statrys, an Asia-based payment platform, put HSBC at the top of the list of banks in Hong Kong. There are pros and cons, as with most companies. The drawbacks were HSBC’s high fees and the difficulties customers had in resolving issues they had with the bank.

There is much room for improvement here.

One of the main risks for the bank is finding a balance between two forces. They are being pulled by the UK and China.

Geopolitical tensions between China and the West don’t seem to be improving much. We’re already seeing an improvement in China’s relationship between Australia and some European countries, but there may be events happening, such as a peaceful solution, or not, with Taiwan, which could be problematic for HSBC.

evaluation

For us, one way to look at a company as a stock of value is to see if the company’s shares are trading at an attractive price, or at least at a fair price, in relation to its net asset value.

In the five years immediately preceding the pandemic, HSBC had been trading at price/net asset value in the 1 to 1.5 range which we think is a fair value but not particularly attractive.

However, as we can see, the bank has been able to raise its NAV per share over the past few years. This has made the price to NAV more attractive.

We also use this to help us research the right time to buy into the company. 2020 was a good year, not only for the entry of HSBC but many other companies. Our point is that when we are not sure what action we want to take, we can often find the answer from the data points. This can make decision making easier.

Conclusion

In our previous analyzes of HSBC, we mentioned that “another potential catalyst for higher share price would be a more shareholder-friendly dividend policy”.

It seems that the market responded by raising the share price of HSBC as mentioned earlier.

In our opinion, provided they can execute on some of their targets, and at the same time hold the three interim dividends at $0.10 per quarter with slow dividend growth in the fourth quarter, more investors will want to get an attractive dividend yield.

If there is such a thing as a “fair price” then we’d say HSBC should be worth HK$75 per share which would still yield 5.5% based on the HK$4.15 we estimate it will distribute for the year. This is a competitor to all other big banks.

As such, we maintain our buying stance.