HSBC Holdings plc: Plenty For Potential For Profit With Little Risk

HSBC (LSE: HSBA) (NYSE: HSBC.US) has fallen out of favour with the market recently. The bank has been sold off by investors who are concerned about falling profits and exposure to the Chinese property market.

However, HSBC has been working to reduce its exposure to the Chinese property market and other risky assets during the past few years. What’s more, declining profits are a result of the bank’s quest for quality over quantity. 

So, after taking these factors into account, it would appear that HSBC’s recent declines could be a great buying opportunity. 

Chinese concerns

HSBC does most of its business in Asia and the bank has reaped that benefits of the region’s growth during the past decade or so. Unfortunately, the recent slowdown in the Chinese property market, has sparked a wave of bankruptcies within the Chinese corporate credit market.

As a result, analysts are becoming increasingly worried about the carry trade, a practice where wealthy individuals borrow money from banks within Hong Kong, to invest within China for a higher rate of interest. It is estimated that this market is worth up to $200bn and a rapid unwinding if markets fell, could lead to a widespread Asian financial crisis.

HSBC will almost certainly be affected by an Asian credit crisis and for this reason alone, many investors have abandoned the bank.

But HSBC’s management has dispelled fears that an Asian credit crisis could spell the end for the bank. Management has stated that while some defaults are likely, the bank’s exposure to bad debt is minimal.

Reducing risk

Indeed, HSBC has significantly reduced its exposure to risky assets and markets during the past few years. Unfortunately, as the bank has retreated from risky areas, sales have declined, although lower profits for less risk seems like a worthwhile trade. 

In particular, HSBC has pulled out of Bahrain, Jordan and Lebanon as high costs and competition saps profitability. Additionally, HSBC has closed some Latin American operations after accusations of money laundering. 

Meanwhile, across the pond, HSBC has shrunk it mortgage loan portfolio, which at one point stood at $118bn but is now worth less than $30bn.

And across the business, the bank has made changes to the way its staff sell products to customers. Staff are now no longer paid on a commission basis but on “balanced scorecard” of performance targets. This has hit profits but customer satisfaction has increased.

Cutting costs

As HSBC de-risks and the bank’s profit comes under pressure, management has started to cut costs, in order to offset falling revenues. For full-year 2014 the bank expects to cut its cost base by $2bn to $3bn. $275m of cost cuts already took place during the first quarter.

As a quick comparison, HSBC’s cumulative dividend payout only cost the company a total of $6.4bn for 2013. So, if the bank reduces costs by up to $3bn per annum, there is scope to increase the dividend payout by around 50%.

This is great news for dividend hunters as HSBC currently has a historic dividend yield of 4.6%. What’s more, City estimates are calling for the bank to offer a yield of 5% and 5.4% for 2014 and 2015 respectively. With HSBC drastically cutting costs, it looks as if this payout is here to stay

City support

Should you buy in? Well, the City has fallen for HSBC’s story and even famed fund manager, Neil Woodford has revealed that he is a fan. Indeed, Woodford believes that the bank is “…well-managed, it has learnt from its mistakes, and it’s cheap…”

Woodford is also attracted to HSBC’s industry-leading Tier one capital ratio of 13.3% and improving balance sheet. Further, HSBC’s rock bottom valuation is hard to pass up as the bank currently trades at a forward P/E of 11.6, similar to the ratio the bank traded at during the midst of the financial crisis. 

However, I'd strongly suggest you look a little closer at HSBC before making any trading decision.

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Rupert does not own any share mentioned within this article.