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Why HSBC Holdings plc Will Struggle To Move Higher

hsbcHSBC’s (LSE: HSBA) (NYSE: HSBC.US) performance this year has hardly been anything to get excited by. In the year-to-date the bank’s share price has fallen 5%, excluding dividends, compared to the FTSE 100’s decline of around 2%. What’s more, over the past five years the bank’s shares have done no better, falling around 6% since 2009, excluding dividends.

Unfortunately, there is reason to believe that HSBC’s poor performance is set to continue. 

Shrinking 

HSBC is currently going through a transition. The bank is pulling out of risky markets and investments, in favour of a traditional banking businesses within Western markets. 

On one hand, this transition is making the bank more stable and secure. However, on the other hand, the bank’s profits are falling. For example, during the first half of this year HSBC reported a pre-tax profit of $12.3bn, 12% lower than the $14.1bn for the same period a year ago. 

What’s more, the bank’s revenue also fell 4% to $31.4bn during the first half of this year, from $32.7bn reported a year earlier. Nevertheless, HSBC’s turnaround plan has seen the industry giant axe more than 40,000 jobs and sell, or close, 60 businesses since 2011, delivering annual cost savings of more than $5 billion.

A great example of how this has affected profitability can be seen in the bank’s profits margins — between full-year 2011 and full-year 2013 HSBC’s operating profit margin expanded from 21% to 26%. 

Falling profits 

But while HSBC’s profit margins are expanding, the bank’s profits are falling, something HSBC’s management has blamed solely on regulators, and an increasing amount of red-tape in the banking industry. 

Still, HSBC’s profits are falling and this means that the bank’s shares are going to struggle to move higher over the next few years. That being said, surprisingly, City forecasts are predicting low single-digit earnings per share growth for HSBC over the next two years.

Indeed, the City currently expects the bank to report earnings growth of 7% this year and 8% next year, although these forecasts are questionable considering the bank’s declining profits. 

Hefty payout

One thing is for certain though and that’s the fact that HSBC’s hefty dividend payout is here to stay.

As HSBC exits risky markets and takes less risk in its remaining ones, the bank’s earnings should become more stable, which will underline the dividend payout. Additionally, the group’s core tier 1 ratio — its financial cushion —  is one of the best in the industry, standing at 11.3%, up from 10.8% as reported at the end of 2013. 

At present, HSBC’s dividend payout is covered 1.7x by earnings per share, implying that the bank has plenty of room for manoeuvre if earnings suddenly decline. The shares currently support a yield of 4.7% and City forecasts expect this yield to hit 4.9% next year and then 5.3% the year after.

With the payout covered nearly twice by earnings per share, there is plenty of room for dividend growth, even if earnings continue to slide.  

Should you buy in?

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

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This exclusive FREE wealth report provides six key 'City insider' valuation metrics for each bank traded in London. That's right, the report is not just limited to HSBC and gives a rundown of the whole industry.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.