HSBC’s Shares Have Sizable Room To Grow Thanks To Tailwinds On Several Critical Fronts

by Trefis Team
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HSBC (NYSE:HSBC) reported a mixed performance for the first quarter of 2018 late last week. While revenues were largely around expected levels, higher operating costs coupled with one-time legal provisions resulted in an earnings miss. We have summarized HSBC’s Q1 earnings and also detailed the major takeaways from the announcement in our interactive dashboard for the company, the key parts of which are captured in the charts below.

The earnings miss triggered a 4% decline in HSBC’s share price when trading opened on Friday, May 4, but the shares recouped some of that by the end of the day. While investors’ disappointment in HSBC’s Q1 results is understandable, we believe that there are some key positive developments that will add value to the bank in the long run.

To begin with, the geographically diversified banking giant continues to benefit from its decision to focus on China over recent years – especially in the rapidly developing Pearl River Delta region, and we expect growth in commercial lending in the region to be one of the most critical growth drivers for the bank going forward. The bank has also done well to report a year-on-year growth in its loan portfolio across all geographic regions besides Europe (where it’s commercial lending portfolio nudged lower compared to Q1 2017).

On the cost front, an important reason for the elevated operating expense figure for Q1 2018 was the bank’s decision to invest $2.3 billion to “enhance (its) digital capabilities.” We believe that this was a necessary expense to ensure competitiveness and sustainability in the rapidly changing financial industry, and could potentially lead to better growth in the long run. Finally, the bank’s decision to set aside ~$900 million to cover legal costs from its ongoing negotiations to settle the legacy U.S. mortgage issue with the DoJ is a prudent move and marks an important step towards putting the issue to rest in the near future.

Taking into account all these factors, we stick to our $55 price estimate for HSBC’s shares, which is about 10% ahead of the current market price.

See our full analysis of HSBC

Net Interest Income Receives A Boost From Higher Margins As Well As Improved Asset Base

An improving interest rate environment globally played an important role in HSBC’s Q1 results. The bank’s net interest margin improved from 1.64% a year ago to 1.67% in Q1 2018. This, coupled with a sharp increase in interest-earning assets from under $1.7 trillion in Q1 2017 to over $1.8 trillion now, helped the quarterly net interest income jump from $6.8 billion to almost $7.5 billion. Net interest income contributed 54.4% of HSBC’s total revenues in Q1 2018 – up from 52.2% in Q1 2017.

Gross Customer Loans Just Shy Of $1 Trillion, With Commercial Loans Driving Growth

HSBC reported gross consumer loans outstanding of over $990 billion at the end of Q1 2018 – a strong 14% growth from $869 billion at the end of Q1 2017. This was driven by a sequential increase in loans across categories, except for loans to non-banking financial institutions (where the bank seems to be cutting its exposure since Q2 2017). The most notable gains over recent quarters have been in HSBC’s commercial lending portfolio, which swelled from $466 billion a year ago to $542 billion now (an increase of 16%). The bank achieved this growth spurt despite its decision to shrink its European commercial lending portfolio, primarily due to increased lending in the Pearl Delta region. Notably, commercial loans now form almost 55% of HSBC’s total consumer loan portfolio.

HSBC’s Push In China Resulted In Asia Contributing ~80% Of Adjusted Pre-Tax Profits

HSBC has made substantial changes to its business model over recent years to keep up with stricter regulatory requirements. This forced it to exit its banking operations in many countries where their low growth potential did not warrant a presence. This has resulted in a notable reduction in the share of North America as well as Europe in HSBC’s profits.

However, the bank chose to double down on its investment in China and other high-growth Asian countries – a move that is yielding considerable gains for the bank. Pre-tax profits for the bank (adjusted for one-time revenues and costs) from Asia was almost $4.8 billion in Q1 2018 – almost 80% of the bank’s total adjusted pre-tax profit of $6 billion.

We expect HSBC to report an adjusted EPS figure of around $3.67 for full-year 2018. Taken together with a P/E ratio of 5 (which we believe is appropriate for the diversified banking giant), this works out to a price estimate of $55 for HSBC’s shares, which is about 10% ahead of the current market price.


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