After a strong January in broader markets, I would like to discuss why I am not ready to invest in the shares of HSBC Holdings (LSE: HSBA).
As a global bank, about three-quarters of the group’s profit comes from mostly corporate clients in Asia. In October 2018, the group delivered a robust set of earnings results. But despite the recent growth in both the top- and bottom-numbers, I feel that investing in this banking giant comes with domestic and global risks.
Continuing Brexit drama
As the official Brexit date of 29 March approaches, the UK faces more uncertainty: we just do not know how we will leave the EU. If the country crashes out without a deal, the initial reaction of the UK stock market will likely be a sharp fall and UK financial shares will remain under pressure.
In the case of a disorderly departure from the EU, British banks and other financial services firms will suffer decreased access to the single market and will also begin to lose their competitive edge in Europe compared to their EU counterparts.
Although HSBC has an international focus more than a domestic one, it is still making preparations for a no-deal Brexit. Like many other UK banks, to continue to have full access to the EU, the group has been moving some of its operations, assets and staff to these countries, mostly to France. All of these extra preparations have been increasing its costs, a fact that obviously affects earnings.
And as Brexit breaking news headlines continue to hit the wires, consumer confidence and investor sentiment regarding the fate of the UK economy will continue to ebb and flow for several more months. The fortunes of banks are closely linked to the overall health of the UK economy and any potential downturn in the economy will hit their bottom line and share price.
It would not be realistic to expect the bank’s share price to be immune to further pressure if the sector suffers. Therefore, until we have more clarity on the next phase of political negotiations, I would wait and see.
Slowdown in China
But isn’t HSBC ‘protected’ by higher exposure to Asia? Recently, the International Monetary Fund (IMF) warned that China, the world’s second-biggest economy, has been slowing considerably. This development would likely translate into falling corporate client demand, decreasing intermediation margins and slower revenue growth for the bank. Indeed HSBC’s exposure to Hong Kong and China has been worrying investors for months and over the past year, the shares have fallen 20%+.
The bank’s P/E ratio is over 14 and its dividend yield stands at 5.1%. Although value investors may be encouraged by these numbers, banking is a cyclical industry — when we have so many question marks about the global economy, it is hard to make a bull case for the sector.
Financials become attractive when the economy takes off, not when it slows down. Therefore, investors should evaluate the bank’s P/E ratio with macroeconomic realities in mind. In recent years, analysts have been lowering the valuations for banking stocks. The fact that HSBC has not increased dividends since 2013 adds to the worry that the shares are not ready to go up.
The bottom line
Markets suffer during times of uncertainty. Therefore, I would avoid committing my capital to this cyclical banking stock.
