HSBC Still Muddling Through And Still Cheap

By Stephen D. Simpson, CFA | February 29, 2012 AAA

Lucky for HSBC (NYSE:HBC) that it's such a globally diversified bank. At present, the company's European and North American operations are adding little to group profits, but Hong Kong remains a cash cow and growth in Asia and Latin America has been quite solid. While institutional investors still seem quite down on this name, and there are definitely risks in emerging markets, patient value investors should be relatively content holding these shares for their long-term potential. (For more, see Earning Forecasts: A Primer.)

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Not a Great Close to the Year
Bank earnings are hard to enough to parse and interpret when it's just a small regional bank; a global bank like HSBC is a maze for even experienced investors. All that said, and acknowledging that not all investors agree when it comes to adjustments, HSBC's fourth quarter earnings weren't great.

Revenue rose about 5% sequentially, but missed consensus expectations by about 3%. Net interest income was surprising strong (albeit down sequentially), while HSBC had similar issues to Citigroup (NYSE:C) and Deutsche Bank (NYSE:DB) with respect to trading income.

Like so many other banks, HSBC is finding it difficult to control costs as well as management hoped. Operating expenses were about 6% higher than expected (and up about 13% sequentially), and pre-tax profits were about 5-10% below most analyst expectations.

Ongoing Transformation in North America
Between selling branches to First Niagara (Nasdaq:FNFG) and the cards business to Capital One (NYSE:COF), HSBC has radically transformed its North American business. For all intents and purposes, HSBC has shifted towards a commercial lending focus and away from retail branch banking. That's probably not a bad decision for the long haul, given how over-banked the U.S. is, and the increasing regulatory burden.

Ongoing Malaise in Europe
HSBC continues to find it hard to make money in Europe. Like Santander (NYSE:STD), HSBC has a large U.K. business that is stable, but not really growing. On the continent, HSBC is hoping for the storms to pass in France and Germany, while also investing in growth prospects like Turkey.

Asia the Star Today and Tomorrow
Where HSBC is doing quite well is in Asia. Hong Kong has long remained an exceptionally lucrative market for HSBC and business there has remained solid enough. Elsewhere, HSBC looks to be in good shape relative to competitors like Standard Chartered in fast-growing markets like Indonesia. Here, too, though is a risk - loan growth has been softening and the vagaries of the emerging Asian banking markets means that another crisis/panic is more of a "when" than "if" question.

The Bottom Line
HSBC has a lot of U.S. subprime runoff left to absorb, but HSBC is underrated on the basis of its exposure to growing banking markets like China, Indonesia, Brazil, Mexico and Turkey. Keep in mind, too, that HSBC owns significant stakes in a variety of Chinese financial enterprises, including Ping An.

More to the point, HSBC has already regained a double-digit return on equity and seems to be in good shape with respect to hitting management's long-term goal of low-to-mid teen ROEs on an ongoing basis.

So what's HSBC stock worth? If you assume that the bank cannot improve its returns and that ROE will remain stuck around 10% on an ongoing basis, the stock should trade for something in the $40-$45 range; more or less in line with today's price. Give the company the bottom of management's expected ROE range of 12% and the target jumps to $55. Go higher still, to the top of management's guidance at 15%, and the target vaults above $70.

While this is certainly a risky name and a complicated business to follow, the risk-reward looks relatively favorable and HSBC could be a good name for patient value-oriented investors.

SEE: 5 Must-Have Metrics For Value Investors

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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