HSBC Holdings plc (SEHK: 5) disappointed investors with a poor first-half report. But have investors overreacted? –
Since last year, HSBC Holdings plc’s (SEHK:5) share price has plummeted. The banking giant has been plagued by bad news.
Investors hoping for a good 2020 half-year performance were further disappointed with revenue falling 9% to US$26.7 billion and profits down 69% to US$3.1 billion.
What went wrong and have investors overreacted to the poor earnings?
What’s the bad news?
Firstly, over half of HSBC’s revenue comes from net Interest income (NII). This is the interest banks earn from lending, less the interest paid to depositors.
With interest rates at historic lows, all banks including HSBC are suffering from lower NII. On top of this, there has been social unrest in HSBC’s main market of Hong Kong and Brexit affecting its other major market, the UK.
And then there’s Covid-19, which has lessened business activity across the globe and raised expected credit losses.
Furthermore, HSBC seems stuck in the middle of geopolitical tensions between the US and China raising concerns about their prospects in China.
Finally, many investors have relied on HSBC’s stable dividends for years. After the Bank of England’s Prudential Regulation Authority requested UK banks suspend dividends for 2020, this has also made the stock less attractive.
With all this bad news, why would anyone want to buy HSBC stock? Well, Warren Buffett once said:
“Be fearful when others are greedy and greedy when others are fearful.”
This doesn’t mean to buy any stock that has fallen significantly but involves looking for great companies that are currently undervalued.
Is HSBC still a great company?
When the economy is weak, you look for financially resilient companies with strong balance sheets.
HSBC, as a prudent bank, maintains a robust capital base. In the latest half-year report, it disclosed a Core Tier 1 capital of 15%, which is generally higher than other banks.
This allows it to buffer against potential credit losses in bad times, yet take advantage of the best opportunities in good times.
HSBC remains a dominant force in Hong Kong, where much of its revenue and profits come from. This was built up over 150 years and won’t be lost easily.
Hong Kong has witnessed a recession but is also expected to rebound earlier than many other economies which locked down later.
The bank is diversified and competitive across multiple segments including Wealth and Personal Banking, Commercial Banking, and Global Banking and Markets.
It is also geographically diverse operating in 64 countries. This has two benefits: it can put money where better opportunities lie and diversification can protect against any country or business segment performing poorly.
Still not convinced?
Banks are complex businesses but in all their complexity the business model can usually be broken down to interest income and non-fund income like fees. After this, you need to subtract costs and bad debts.
As mentioned, more than half of HSBC revenue comes from interest income, so until interest rates go up, or HSBC can earn more fee income, revenue will be subdued.
This is not ideal but it is the same story for other banks and does not weaken HSBC’s long-term competitiveness.
What about costs? HSBC realises it needs to improve operating efficiency. It plans to reduce its 233,000 employees by 35,000, which should enhance its current cost-efficiency ratio of 61.8%.
A key concern banks face is bad debts, and Covid-19 may lead to many companies struggling to repay debts.
Most banks, including HSBC, expect that the second half of 2020 will see lower expected credit losses as provisions were made in the first half and they expect the economic impact of Covid-19 to improve.
No dividend this year, limited upside until the economy recovers and interest rates rise, and scary news.
While things don’t look great for HSBC, sometimes the market can overreact to negative news. If HSBC’s stock continues to fall, it may be an opportunity to pick up some shares.
Ultimately, I think HSBC will be around for a long time for the reasons I mentioned. If there is a strong recovery in the economy, the bank can deploy its capital, if not then it could return capital to shareholders. Either way, HSBC stock could rally.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Robert Chan owns shares of HSBC Holdings plc.
The Motley Fool Hong Kong Limited(www.fool.hk) 2020