The Motley Fool

Are Yields At HSBC Holdings plc (7.5%) And Morgan Advanced Materials PLC (5.5%) About To Be Slashed?

With investor sentiment towards China declining in recent months, the outlook for HSBC (LSE: HSBA) has deteriorated in the eyes of many investors. Certainly, the growth rate of the world’s second largest economy is slowing and there are concerns regarding the health of its banking system. However, in the long run it remains a hugely enticing opportunity for banks such as HSBC to meet rising demand for credit from China’s expanding middle class.

In the short run though, there are worries about the performance of HSBC given the near-term outlook for China. As a result, its shares have fallen by 15% since the turn of the year and this has caused its dividend yield to rise to a whopping 7.5%. That’s almost twice the FTSE 100’s 4% yield and shows just how bearish the market is regarding HSBC’s future prospects.

However, HSBC remains a very financially sound bank with a sensible strategy to improve its cost-to-income ratio. For example, it’s cutting staff numbers and seeking to generate productivity improvements across the business, which is likely to boost its profitability over the medium term. But even if profit growth isn’t forthcoming, HSBC’s dividend is still covered 1.5 times by profit and this indicates that the chance of a dividend cut is slim.

Furthermore, with the bank trading on a price-to-earnings (P/E) ratio of just nine, there’s tremendous upside potential from a rerating in the coming years. Therefore, while the market is fearful regarding HSBC’s future prospects, it could be a good time for income and value investors to buy it for the long term.

Sound buy?

Also suffering from declining investor sentiment in recent weeks has been industrial company Morgan Advanced Materials (LSE: MGAM). Its shares are down by 14% since the turn of the year and a key reason for this is the expected decline in the company’s bottom line. In fact, Morgan Advanced Materials is expected to report a 4% fall in its net profit for 2015, with the same fall forecast in the current financial year.

This clearly reduces its headroom when making dividend payments, but with shareholder payouts expected to represent just 57% of profit in the current year, there seems to be adequate scope to increase dividends over the short-to-medium term, even if profitability comes under pressure. And like HSBC, there’s scope for an upward rerating to Morgan Advanced Materials’ valuation, since it trades on a forward P/E ratio of just 10.4 at the present time.

Certainly, industrial companies such as Morgan Advanced Materials are more susceptible to deterioration in the global macroeconomic outlook, with demand for their products being relatively cyclical. However, with a well-covered yield of 5.5% and a low valuation, it appears to be a sound buy for the long term.

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