HSBC
Shares in HSBC (LSE: HSBA) have one of the lowest valuation multiples in the large-cap banking sector in the UK, with a 7% discount to its tangible book value. Profitability has been steadily improving for the bank, but HSBC still faces major structural and cyclical headwinds in the near term.
Slowing emerging market economies pose a very real risk to its earnings in a number of ways, as slowing growth usually leads to slower lending and lowers the credit quality of its loans. In addition, the tumbling value of many emerging market currencies means HSBC will take a hit when it translates its foreign profits back into dollars, its reporting currency.
On the structural side, the bank faces increasing regulatory scrutiny, causing it to carry more capital and incur more compliance costs than many of its smaller competitors. Its cost to income ratio remains stubbornly high, at 58.2% for the first half of 2015, and it seems unlikely that it could sustain a mid-50s figure for the full year.
However, analysts are still optimistic with earnings over the next two years. They currently expect underlying EPS will rise 16% to 52.2p in 2015, which gives its shares a forward P/E of 10.1. For 2016, underlying EPS should grow by another 2% to 53.0 pence, and this will mean its forward P/E of earnings in the following year will fall to just 10.0.
RBS
Royal Bank of Scotland Group‘s (LSE: RBS) 25% price-to-tangible book discount may make the bank seem cheaper than HSBC, but this is down to its much weaker profitability and uncertainty about the market value of the assets on its balance sheet. The bank is making progress with cutting costs, but investors should expect a long ride before profitability returns to ‘normal’ levels.
Restructuring costs continue to mount, and the bank needs to accelerate the sale of its under-performing assets. The prospect of further fines seems never ending, and the bank’s £5.4 billion litigation provision may not fully reflect the potential costs.
Its shares may trade at 11.8 times its expected underlying earnings in 2015, but earnings is expected to be volatile. Analysts expect underlying earnings will fall again, by 11% in 2016, which implies its share trade at 13.9 times its earnings in 2016.
Bank of Georgia Holdings
Bank of Georgia Holdings (LSE: BGEO) is growing strongly, despite Georgia’s close economic ties with Russia and the depreciation of the Georgian lari. Unfortunately, there are also signs that trading conditions could get a lot worse.
Bank of Georgia’s non-performing loans ratio rose substantially in its most recent quarter, rising 60 basis points on the previous quarter, to 4.1%. Credit quality could worsen further, and improvements in margins and cost efficiency seems unsustainable. Underlying earnings is set to fall 12% this year, to 203.4p, which implies its shares trade at a forward P/E of 9.3.
The bank is set to benefit from the anticipated IPO of its healthcare subsidiary, Georgia Healthcare. This could prove to be a very positive near term catalyst for the bank, as the timing of the listing is unlikely to get much better. Valuations for healthcare stocks carry a premium to the market, and the listing could raise some much needed funding for the bank’s growth plans and shore up its balance sheet.
Conclusion
All three banks will likely face some major headwinds, but HSBC is most attractive of the three because it has the most optimistic outlook on earnings growth. And, although HSBC is not the cheapest bank on valuations, it has the highest dividend yield in the sector, at 6.1%.
