Why I’m Bullish On HSBC Holdings plc After Profits Rise By 10%

Today’s half year results from HSBC (LSE: HSBA) are hugely encouraging and show that the bank is making considerable progress towards becoming a more efficient and profitable entity. In fact, the results have beaten market expectations, with the bank delivering a 10% rise in pre-tax profit, reaching $13.6bn versus $12.3bn in the first half of 2014.

This was mainly due to the strong performance of the Chinese stock market earlier this year, which caused investment-related activity in HSBC’s Hong Kong division to soar. As a result, HSBC’s pretax profit for the first half of the year was considerably higher than the $12.5bn expected by the market. Despite this, its shares are up by less than 1% at the time of writing.

A key reason for this is doubt surrounding the short term performance of the bank, with the recent fall in the Chinese stock market likely to have a detrimental impact on its near-term outlook. Still, HSBC is expected to increase its bottom line by as much as 21% this year, which is likely to positively catalyse investor sentiment in the stock.

In transition

Of course, HSBC remains a bank in transition. For example, its costs continue to rise and, while various cost savings have been identified and are likely to come through over the medium term (aided by planned job cuts of up to 50,000 over the next few years), adjusted operating costs increased by 7% in the first half of the year.

Certainly, this was due to investment in growth, as well as regulatory and compliance costs, but it indicates that HSBC remains relatively inefficient when compared to many of its sector peers which have been able to reduce costs while delivering rising incomes in recent years.

Furthermore, the Chinese economy is enduring significant change and it remains a relatively unstable period for the world’s second largest economy. This impacts on the wider Asian economy, which HSBC relies on for two-thirds of its profit, and means that investor sentiment in the bank is relatively weak. Evidence of this can be seen in HSBC’s current rating, with the bank currently trading on a price to earnings (P/E) ratio of just 11 despite having strong growth prospects for the current year.

Substantial changes

Meanwhile, HSBC also today announced the sale of its Brazilian asset, Banco Bradesco, for around $5.2bn and is said to be close to selling its underperforming Turkish operations. And, with assets being cut by $50bn on a risk-adjusted basis in the first half of the year, HSBC is making substantial changes to its balance sheet and operations at a relatively brisk pace.

As a result of these changes, HSBC is likely to emerge as a stronger, more efficient bank with a much more appealing risk/reward profile. Certainly, the sale of assets, loss of jobs and repositioning of the bank towards Asia is likely to cause a degree of uncertainty and additional costs in the short run (especially if the recent fall in the Chinese stock market continues). However, with the region having such vast long term potential, it appears sensible for HSBC to focus on Asia when it comes to long term growth.

And, with the bank performing well in the first half of the year, being expected to post double-digit growth in earnings for the full year and trading on such a low valuation, now appears to be a perfect time to buy a slice of it.

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Peter Stephens owns shares of HSBC Holdings. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.