Standard Chartered (LSE: STAN) is a company that has gone from being a high yielding stock market darling, with ample exposure to emerging markets, to sector laggard and almost an index leper — all within a 24 month period.
Although it’s not the only banking stock to have performed poorly in recent times, year-round weakness in core markets and the effects of a recently announced rights issue mean that Standard Chartered has been the worst performer among London listed financials, with total losses for the shares now coming in at 29.4% for the year to date.
It is with this in mind that I’m going to consider both the bear and bull cases for Standard Chartered;s prospects.
The Bear Case
Standard Chartered is exclusively focused upon emerging markets, with Asia, Africa and the Middle East being at the heart of group operations.
Where such exposure was once the be all and end all for most companies, today — emerging markets are often seen as the weak link within both business and investor’s portfolios.
Part of this problem is the result of the ongoing rebalancing effort within the world’s second largest economy. However, China is not the only source of latent scepticism toward emerging markets, as the developing world in general is now grappling with a number of problems.
First and foremost, household, corporate and government balance sheets have expanded considerably across the emerging market space since the dark days of the financial crisis.
Secondly, with the Federal Reserve possibly just a short distance away from the beginning of a rate-hiking cycle, the prospect of an ever stronger US dollar relative to emerging market currencies is now becoming a reality.
The implication of these two sets of problems is that swollen balance sheets could become infeasibly expensive to service in the emerging market world and, given that growth in these economies is now beginning to slow, there is now an increased level of credit risk that the group must contend with.
The Bull Case
Standard Chartered has already taken action to cut costs by reducing headcount, slimming down its bloated management structure and reducing its investment banking operations (eg, the disposal of equity trading division).
The group is also taking action to rebalance its own business away from corporate and investment banking, in favour of a greater focus upon retail banking services for wealthy individuals.
Furthermore, with management now having taken the plunge and announced a $5.1 billion rights issue to shore up the group’s capital base, it would seem that almost all of the bad news that could have expected is now out in the open and dealt with.
Assuming that emerging markets avoid another collapse in the coming quarters, this represents an opportunity for management to back-bench the non-performing loans issue and begin thinking about the future in terms of shareholder returns.
Cheap or expensive?
From a valuation perspective, Standard Chartered now trades on 14.6x the consensus for 2015 earnings, which is expensive relative to both its nearest competitor HSBC — as well as the banking sector in general, at just 11.5x.
However, it is also worthy of note that both Standard Chartered and HSBC currently trade at a considerable discount to their tangible book values — with Standard Chartered trading at 0.43x tangible book value per share and HSBC at 0.74x.
What to do?
The uncertain outlook for emerging markets makes Standard Chartered shares a high-risk play for any investor. Although a fresh infusion of capital may be enough to avert a balance sheet disaster in the near term, my natural sense of scepticism tells me that it will just be a temporary respite.
Furthermore, unless earnings estimates are wildly off, it would appear that the shares are probably overvalued relative to many of their blue-chip banking compatriots. At the very least, if they aren’t overvalued, then it seems fair to say that for those who want exposure to emerging market financials there is probably better value to be had from HSBC.
