Too big to succeed?
The main reason why HSBC (LSE: HSBA) has underperformed ever since the financial crisis is because it has become too big and too complex. HSBC has become systemically very important to the global banking system, causing regulators to require the bank to hold more capital than its peers and to spend more on regulatory compliance. All this puts HSBC at a disadvantage against local rivals and smaller specialist investment banks.
To be sure, Barclays (LSE: BARC) is a complex financial institution too. The bank has operations across multiple countries and offers a broad range of banking services, ranging from mortgages and credit cards to investment banking and wealth management. However, with the bank making greater steps to become a simpler operation, including selling down its majority stake in its Africa banking unit and shrinking its investment bank, Barclays has much greater potential to reduce costs and restore profitability.
Valuations
| Barclays | HSBC | |
|---|---|---|
| Price-to-tangible book value | 0.53 | 0.75 |
| Forward P/E (2016E) | 11.6 | 10.2 |
To a certain extent, of course, the reason why shares in Barclays sell for a bigger discount to book value than shares in HSBC is simply because investors expect HSBC will grow earnings faster. But contrary to this, City analysts expect Barclays will grow earnings faster than HSBC over the next two years. Barclays’ adjusted EPS is set to grow 9% this year and 49% in 2017. This would give it forward P/Es of 11.6 and 7.3 for 2016 and 2017, respectively.
Meanwhile, HSBC faces multiple headwinds, ranging from slowing growth in China, to rising loan losses tied to struggling mining and energy sectors. And this is before we take into account the stricter Basel III capital requirements, which will become fully implemented by 2019. Analysts expect HSBC will need to raise additional capital to comply with its 2019 Basel III milestone, potentially through a dividend cut or a rights issue, which would most certainly not be what investors will be looking forward to.
HSBC’s adjusted earnings are forecast to shrink 9% this year, before growing back by 8% in the following year. This would give it forward P/Es of 10.2 and 9.7 on 2016 and 2017 earnings, respectively.
Dividends
HSBC’s 8.0% dividend is very tempting. Unfortunately, its dividend is on shaky foundations, with earnings covering payouts by less than 1.3 times in 2015. Near-term headwinds and stricter capital requirements will likely make it even more difficult to maintain the payout. And already, dividend futures are pricing a 22% dividend cut for 2017.
Barclays’ dividend right now gives investors little to write home about, with the bank having reduced its payout by 54% earlier this year. However, the dividend outlook could soon change as the bank is set to improve its capital position and profitability. In doing so, Barclays would soon be in a better position to distribute more earnings to income-hungry investors.
The bottom line
HSBC is not an attractive investment for me right now as the risk-reward profile is unfavourable. The bank faces multiple headwinds and valuations simply don’t seem cheap enough.
Barclays on the other hand looks far more alluring. There is a strong recovery potential for earnings, and the stock is cheap on a valuation basis.
