HSBC Looks Undervalued As Asian Economy Gets Back On Track

HSBC stock (NYSE: HSBC) lost nearly 40% – dropping from $40 at the end of 2019 to around $24 in early April – before further declining to around $22 now. This implies the stock is around 45% lower than at the start of the year.

There are a couple of reasons for this:  The Covid-19 outbreak and economic slowdown meant that market expectations for 2020 and the near-term consumer demand plunged. This could negatively affect businesses and individuals, impacting their loan repayment capability and exposing HSBC to sizable loan losses. Moreover, geopolitical uncertainty due to heightened tension between the US and China continue to adversely impact the bank’s performance.

But does it mean HSBC stock is undervalued? Sure, it does.  Trefis estimates HSBC’s valuation to be around $26 per share – about 20% above the current market price – based on an upcoming trigger explained below and one risk factor.

The trigger is an improved trajectory for HSBC’s revenues over the second half of the year. We expect the company to report $52.5 billion in revenues for 2020 – lower than the figure for 2019. Our forecast stems from the belief that as economic conditions have started to recover in Q3, the bank’s performance will steadily improve. Further, the easing of lockdown restrictions in most of the world is likely to help consumer demand, benefiting the overall business scenario. Moreover, HSBC’s Asia banking business has remained robust, with the bank reporting a profit of more than $7.3 billion in YTD 2020. The bank’s investment banking operations have driven positive revenue growth in Q1 and Q2 due to higher trading volumes, with the bank’s trading revenues surging by 35% in the first half of 2020 as compared to the year-ago period. On similar lines, HSBC’s advisory and underwriting fees saw significant growth in the first half of 2020 due to a jump in debt underwriting deals after the Fed stimulus. This has partially offset the impact of weak revenues in other segments. While we expect the trading income to drop in the subsequent quarters, it is likely to be still higher than the year-ago period. Overall, we see the bank reporting an EPS in the range of $1.02 for FY2020.

Thereafter, HSBC’s revenues are expected to improve to $53.7 billion in FY2021, due to an increase in retail revenues, partially offset by a decline in sales & trading revenues. Further, the net income margin is likely to grow as compared to the previous year due to a decline in provisions for credit losses, leading to an EPS of $1.91 for FY2021.

Finally, how much should the market pay per dollar of HSBC’s earnings? Well, to earn close to $1.91 per year from a bank, you’d have to deposit about $191 in a savings account today, so about 100x the desired earnings. At HSBC’s current share price of roughly $22, we are talking about a P/E multiple of just below 12x. And we think a figure closer to 13.5x will be appropriate.

That said, banking is a risky business right now. Growth looks less promising, and near-term prospects are less than rosy. What’s behind that?

HSBC has a huge portfolio of consumer, commercial, and wealth management loans – more than $1 trillion in FY 2019. The economic downturn could deteriorate the loan repayment capability of its consumers, exposing the bank to significant loan defaults. In anticipation of this risk, HSBC has increased its provisions for loan losses from around $1.1 billion in the first half of 2019 to $6.9 billion so far – a 6x jump. If the economic condition worsens, this figure could further increase in the subsequent months. Further, a negative economic outlook will make it expensive for the bank to attract funding, increasing the cost of its operations. To sum things up, we believe that HSBC’s stock is currently undervalued and offers upside, given its strong retail and investment banking operations.

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