This week’s results from HSBC (LSE: HSBA) were slightly better than expected and showed that the bank is making encouraging progress.
Of great importance to the bank’s investors was news that despite slowing growth in the mainland Chinese economy and market volatility in Asia, there has been no visible impact on HSBC’s Asian credit quality in the third quarter of the year. And, while revenue did fall versus the comparable period in 2014, the bank’s operating expenses also fell when compared to the second quarter of the year.
Behind the curve
Clearly, investor sentiment in HSBC is rather weak at the present time and a key reason for this is its high exposure to the slowing Asian economy. The decision to pivot towards Asia, though, is likely to be a sound one in the long run, as the penetration of financial products in the region is still relatively low despite the rapidly growing level of individual wealth. Therefore, HSBC has huge long term growth potential – especially as the Chinese economy gradually shifts from being capital expenditure-led and towards a more consumer-focused economy, where credit needs are greater.
Of course, HSBC has been behind the curve in terms of its cost base and, while operating expenses did fall versus the second quarter of the year (as mentioned), they were still up when compared to the third quarter of 2014. However, with HSBC undertaking a number of initiatives in this space, including the potential for a relocation of its head office to Asia and thousands of redundancies, it looks set to catch up to its banking rivals somewhat in the coming years.
With HSBC’s shares having fallen by 21% in the last year, they are now among the cheapest and highest yielding in the FTSE 100. For example, HSBC trades on a price to earnings (P/E) ratio of only 9.8, which indicates significant upward rerating potential, while its yield of 6.7% is among the highest in the index and is well-covered by profit as evidenced by a payout ratio of 65%.
Tremendous opportunity
In the next couple of years, HSBC may lack a catalyst to push its share price higher. Certainly, its focus on costs is likely to boost margins and improve profitability, but moving its shares onto a higher rating may require a boost from external factors, such as a stabilisation in the outlook for the Chinese economy.
On this front, there is tremendous opportunity for HSBC to benefit, since it is extremely well-placed to become a key part of China’s next growth stage, with a whole host of financial products likely to be required by a Chinese middle class which is due to increase by 326m between 2014 and 2030.
So, while a small fall in revenue is disappointing, and HSBC’s cost base is relatively high, its long term growth outlook remains hugely encouraging. And, in the meantime, it offers a superb yield and substantial rerating potential.
For long term investors, now seems to be the perfect time to buy a slice of it.
