After falling close to a five-year low at the beginning of the year’s second half, HSBC (LSE: HSBA) shares have begun to look abnormally cheap when stood next to their peer group.
Even after last week’s Q3 results, which have already prompted a small bounce in the share price, the group’s low valuation and progress toward its restructuring targets have left the shares looking tempting.
Weathering the storm
One of the most positive things to come from the Q3 update was management’s declaration that there had been “no deterioration in Asian credit quality” as a result of the worldwide volatility in financial markets following the quarter’s collapse of the Chinese equity market and news of deepening slowdown in the nation’s economy.
While the threat from rising loan delinquencies has long been an important factor in the underperformance of HSBC’s shares during recent times, there has actually been no such deterioration recorded in the loan book for 2015.
On the contrary, loan impairments have fallen across most geographies where the group operates but most notably in the US, which has resulted in a 20% reduction in total impairments for the year to date.
Furthermore, despite some businesses having been hit by low commodity prices and the slowdown in China, the group has benefited from increased activity in Asian financial markets during recent periods, which has been the result of the Shanghai/Hong-Kong stock connect coming online late last year and generally outweighing the impact of the third quarter’s turbulence.
Restructuring & dividends
Last week’s results also highlighted a reduction in risk weighted assets of $32 billion during the quarter and $82 billion year to date, which is 29% of the total $291 billion that the group intends to dispose of before the end of 2017.
Although the long-term plan is to redeploy any cash realised from asset sales to higher margin areas, management have already said earlier this year that they do not expect to find suitable opportunities for all of these funds, which is positive by implication for dividends and other cash returns to shareholders.
Attractively Valued
In addition to the better-than-expected financial performance of the bank during the quarter, the shares currently trade at a very slight premium to tangible book value, at parity with their total book value per share and on a forward price-to-earnings based valuation of 10.2x the consensus estimate for 2015 earnings.
This values the shares at broadly the similar level to that which we last saw during the 1997/8 Asian financial crisis, and at a modest discount to the 11.18x average of its London peer group.
Foolish Final Thought
In an environment where growth all too often comes with ever-increasing levels of risk and ever more onerous regulatory capital requirements, some analysts are now beginning to favour those banking organisations who have opted to focus on ROE’s and ROCE’s over pure asset and earnings growth.
The rationale for this is simple in that banks can improve their attractiveness to investors by slashing costs, hiving off riskier assets and exiting more capital-intensive businesses.
The boost to ROE and cash returns to shareholders that results from this can often outweigh the value of ‘growth’, particularly after adjusting for the disparity in risk between the two strategies.
HSBC was among the first to adopt a more returns-focused approach to its business, and after this year’s emerging market induced sell-off in the shares, it is probably the London banking stock that offers the most attractive risk/reward pay-off in my view.
In fact, for those investors who either lack exposure to the sector or who are just looking for their next investment, I would go so far as to say that it is probably the only one that is actually worth buying at current prices.
