Despite the sell-off in emerging market assets, the latest financial results from HSBC Holdings (LSE: HSBA), Aberdeen Asset Management (LSE: ADN) and Ashmore Group (LSE: ASHM) show these companies continue to deliver earnings growth. But there are signs showing that the trend of steady earnings growth is unlikely to continue for much longer and that the turmoil in emerging market is far from over.
Economic conditions in many emerging market economies, most notably China, are only just beginning to worsen, and funds flowing out of emerging markets have been accelerating in recent months. These trends will likely continue in the medium term, and this should lead to a widening of the valuation gap between the shares of companies with strong emerging market exposures and the shares of companies that focus primarily on developed markets.
Shares in HSBC may seem cheap, as they currently yield 6.4% and trade barely above its tangible book value. But with the slowing economies in China and the rest of Asia, there is a high risk that the rising level of loan losses will crimp earnings growth in the coming years. HSBC’s trend of declining loan impairment charges in Asia ended in the first half of this year, and the turmoil in emerging markets seems to have only just begun.
In addition to slowing emerging market economies, HSBC needs to deal with a high cost structure and weak profitability almost everywhere outside of Asia. The bank suffers from being overly complex and has capital spread too thinly over too many markets. In order to regain competitiveness, the bank plans to sell some of its underperforming businesses and return to its roots in Asia.
A re-focus on Asia would make sense in the long term, as HSBC’s latest interim results showed it earned 69% of its profits there, despite the region accounting for only 36% of its assets. But, in the short term, this strategy has its disadvantages. Divestments from businesses outside of Asia will have an immediate negative impact on bank’s top and bottom line, and a renewed focus on Asia would leave HSBC more exposed to a slowdown in China and the rest of Asia.
Aberdeen Asset Management
In the three months ending 30 June 2015, investors withdrew £9.9 billion from Aberdeen’s funds. The rate of net outflows from Aberdeen has been accelerating in recent quarters, as the sell-off in emerging markets deepens. Emerging markets account for more than 60 per cent of Aberdeen’s £107 billion equity portfolio, which explains why Aberdeen has been hit particularly hard by the sell-off in emerging markets.
Assets under management declined by £23.3 billion in the quarter, as falling asset prices and negative currency effects compounded the loss in the value of Aberdeen’s portfolio of funds. With funds under management shrinking, falling asset management and performance fees would lower Aberdeen’s earnings. Analysts currently expect underlying EPS will decline 6% in 2015 and 3% in the following year, but if recent trends are anything to go by, the outlook on earnings could be much worse.
Ashmore reported a 6% increase in pre-tax profits for the year ending 30 June 2015, despite a 21% fall in assets under management. The divergence between earnings and assets under management is unsustainable in the longer term, and analysts currently expect Ashmore’s underlying EPS will decline by 15% next year.
With assets under management being regarded as an important indicator of future profits in the asset management business, Ashmore’s outlook on earnings is pessimistic. The outlook on its dividend is also negative, as Ashmore’s dividend cover is expected to decline from 1.16x this year, to just 1.03x in 2016. If Ashmore is unable to sustain its progressive dividend policy, shares in the company could have much further to fall.