HSBC is a great business – but buy Standard Chartered

HSBC is a great business – but buy Standard Chartered

By Garry White
Published: 5:17PM BST 03 Aug 2009

HSBC

635.9p +30.15


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Questor says AVOID

This column has shied away from recommending Western banks over the last six months, as there were too many uncertainties in their balance sheets. The full impact of bad loans has not worked its way through the system and there are a number of new regulatory hoops that look likely to be imposed. Caution continues to be the order of the day.

HSBC did not need to take government funds when other institutions were crumbling at the foundations, although it tapped existing shareholders for more money through a rights issue in April, raising $17.8bn (£10.5bn). This is a major positive for the group.

Yesterday's first-half report was relatively reassuring. Pre-tax profits in the six-month period to June 30 fell 51pc to $5bn on a year-on-year basis on revenues that were 10pc ahead of last year. Reassuringly, its Tier One ratio rose to 10.1pc from 8.3pc six months ago.

This is ahead of the 7.5pc – 10pc range targeted by the bank, with most of this extra funding coming from the group's cash call earlier this year.

HSBC still owns Household in the US – a sub-prime lender. The company paid $15bn for the business in 2003 and the bank – after defending the purchase for quite some time – admitted that it has made a mistake earlier this year. "With the benefit of hindsight, this is an acquisition we wish we had not undertaken," Stephen Green, HSBC's chairman, said in March.

Rising bad debts in the US, Europe and Asia forced the bank to write off $13.9bn, which was one-third higher than in the same period last year. This is a lot of money – even for a bank of the size of HSBC. The bank has had to make some $67bn of bad loan provisions in the last three-and-a-half years, most of these associated with Household.

Although there is the suggestion that bad debts could have peaked, this may not be the case. If you look at the stock market's recent performance, you would think that the future is rosy and bright. It is not. Unemployment looks set to rise and bad debts are going to take some time to work their way through they system. This is the main reason Questor is cautious

It is easy to argue that HSBC is managed better than most other "western" banks – because it's probably true – and there is no doubt that it has a great future ahead of it. The company's heavy exposure to Asia is a real positive.

However, it's a question of valuation. The shares have rallied substantially from their lows, more than doubling since March. This means that the shares are trading on a December 2009 earnings multiple of 28.6, falling to 21.5 next year and 13.8 in 2011. This looks pretty steep. The shares are only yielding 3pc as well, which is hardly earth shattering when compared to some of the dividend plays we have in the Questor portfolio such as Northern Foods (7.4pc) and BP (6.8pc).

Questor advises readers to buy shares in Standard Chartered instead. The bank was recommended when its shares were at £12.40 and they are now 18pc ahead of their initial recommendation price.

The shares are yielding just 2.4pc this year, but this is not a share to buy for income, it's a share to buy for long-term growth. The company operates in markets that have significant growth ahead and is heavily exposed to the Middle East. It escaped the collapse in global financial markets relatively unscathed and it is trading on a December 2009 earnings multiple of 15.7 times.

Standard Chartered publishes its interim figures today. Consensus is for earnings per share of 91 cents, with a range of 80 cents to $1.07.

So, although things are looking relatively good for HSBC, concerns about bad debts remains and the valuation looks pretty rich. Questor advises avoiding shares in HSBC for now, playing the banking sector through Standard Chartered which is highly geared to most of the long-term growth markets in the world.

http://www.telegraph.co.uk/finance/markets/questor/5967064/iHSBC-is-a-great-business-i-but-buy-Standard-Chartered.html