Shares of global banking giant HSBC (LSE: HSBA) were in demand following last year’s Brexit vote, as investors favoured international businesses over those with a domestic focus. However, after a strong run — and closes above 700p on four consecutive trading days in mid-February — the shares have drifted lower.
Are they worth buying at their current level of 665p? How soon can they get back above 700p? And what are the longer-term prospects?
The market was underwhelmed by HSBC’s annual results, which were released on 21 February. The statutory numbers were poor, due to one-off items, but the adjusted numbers were also below consensus forecasts. This was due to a weaker than expected Q4 performance in which below-par revenue fed through to adjusted profit before tax of $2.6bn — 26% below the consensus forecast of $3.3bn.
However, the company pointed to an improving outlook for 2017, with much of the heavy investment in reshaping the bank completed and, at the macro level, signs of a cyclical upturn. Q1 results last week seemed to confirm the brighter outlook. Adjusted profit before tax came in at $5.9bn, with the majority of the group’s businesses performing well.
Major restructuring since the financial crisis, the requirement to hold higher levels of excess capital, fines and compensation, increased compliance costs and unprecedented low interest rates have all combined to make profitability a challenge for banks.
Despite this unfavourable backdrop, HSBC has still managed to deliver value for shareholders. For example, over the last five years, its share price has increased by 110p and it’s paid out dividends of 165p, for a total return of almost 50%.
With most of its restructuring and legacy issues behind it, a strong balance sheet and a more favourable environment of gently rising interest rates in prospect, HSBC looks set to deliver increasing annual profits.
Well worth buying?
At the current share price of 665p, the price-to-book (P/B) ratio is 1.1 and I calculate a normalised price-to-earnings (P/E) ratio of 11. This is based on adjusted pre-tax profit, the blended standard tax rates in the countries in which the group’s profits arise, and current exchange rates.
If HSBC can demonstrate continued progress in the upcoming quarters, with earnings advancing and indications that the return on equity (ROE), currently running at 8%, is moving towards management’s medium-term target of at least 10%, I can see the shares regaining 700p this year.
If HSBC were already delivering double-digit ROE, I reckon the shares would be trading at 900p-plus today — a P/B of 1.5 and a P/E of 15. So, with a fair wind to the end of the decade, I wouldn’t be surprised to see a price above 1,000p by 2020.
In the meantime, with the company saying it’s confident of maintaining its dividend at the current level, investors can also look forward to an annual yield of 6%. This generous payout and my expectations of a re-rating of the shares over the next few years, lead me to believe they are well worth buying at their current level.
G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.