Impressive 1H Earnings for HSBC

HSBC Holdings plc’s (HBC) earnings came in at 54 cents per share in the first half of 2013, surpassing the prior-period figure of 45 cents. Net profit came in at $11.3 billion, rising 25% from the comparable period last year.

Strong results were driven by top-line improvement, growth in total operating income and reduced operating expenses. Further, robust performance in all businesses except Global Private Banking acted as a tailwind. Moreover, capital and profitability ratios improved as well.

HSBC exhibited significant progress in strategically reshaping itself and improving its returns. Since the beginning of 2011, the company announced the divestiture or closure of 54 of its non-core/unprofitable operations across the globe. Moreover, HSBC generated cost savings of $0.8 billion in the first six months of 2013, leading to annualized total savings of $4.1 billion.

Performance in Detail

The underlying profit before tax was $13.1 billion in the first half of 2013, surging 47% from the prior-year period. The rise primarily came on the back of increased revenues and decreases in loan impairment charges and expenses.

Total revenue (on an underlying basis) came in at $33.3 billion, climbing 4% from $32.1 billion in the previous year period. The improvement was largely driven by revenue growth in key areas of HSBC’s global businesses.

Total operating income fell 7% from the year-ago period to $40.5 billion. The decline was mainly due to decreases in net interest income and other operating income, partially offset by increases in net trading income, fee income and dividend income.

Underlying total operating expenses were $18.3 billion, decreasing 8% from $19.9 billion in the prior-year period. The decline was mainly due to a reduction in charges related to the U.K. customer redress programs as well as restructuring and related costs.

The underlying cost efficiency ratio decreased to 55.0% from 62.1% in the comparable period last year. A fall in efficiency ratio indicates rise in profitability.

Performance by Business Line (on underlying basis)

Retail Banking and Wealth Management: The segment reported $3.3 billion in pre-tax profit, up substantially from $1.3 billion in the prior-year period. The rise was driven by lower loan impairment charges in the U.S. run-off portfolio and a fall in expenses.

Commercial Banking: The segment reported pre-tax profit of $4.1 billion, up 4% from the comparable period last year. The increase was mainly due to higher revenues, lower operating expenses and increased income from associates, which were partially offset by higher loan impairment charges.

Global Banking and Markets: Pre-tax profit for the segment was $5.7 billion, increasing 20% year over year. The segment’s results improved on the back of higher revenues and lower loan impairment charges.

Global Private Banking: Pre-tax income for the segment was $108 million, down 76% from $457 million in the prior-year period. The deterioration was due to fall in revenues, partly offset by lower operating expenses.

Other: The segment recorded a pre-tax loss of $230 million against $1.6 billion in the prior-year period.

Profitability and Capital Ratios

Profitability ratios improved in the first half of 2013. Annualized return on equity rose to 12.0% from 10.5% in the prior-year period. Moreover, pre-tax return on risk-weighted assets (annualized) increased to 2.6% from 2.1% in the prior-year period.

HSBC continued to generate capital from its retained profits. The company’s core Tier 1 ratio as of Jun 30, 2013 improved to 12.7% from 11.3% as of Jun 30, 2012. Total capital ratio also rose from 15.1% as of Jun 30, 2012 to 16.6% as of Jun 30, 2013.

Other Developments

In an effort to further improve overall efficiency, HSBC announced a second round of cost saving initiatives in May 2013. The new cost saving program will start from 2014 and run for 3 years. The company plans to slash $3 billion in costs in 3 years. Under the new cost savings plan, the workforce will plummet by 14,000 by the end of 2016 to 240,000.

Despite over-achieving cost savings, HSBC has not been able to meet its core efficiency ratio goal. Hence, the company changed core efficiency ratio target to the mid-50% range from the prior guidance of 48–52% range.

Notably, HSBC anticipates both revenues and risk-weighted assets to grow 8–9% annually. It also remains focused on high-growth emerging markets, while expecting about 90–95% of pre-tax profits from growth in core countries.

HSBC reiterated its ROE and dividend payout ratios, while meaningfully deploying capital by resuming share repurchase activity in 2014 (subject to shareholders’ as well as regulatory approvals). The company expects to achieve ROE in the range of 12–15% and will maintain a dividend payout ratio of 40–60%.

Further, HSBC revised its Tier 1 common equity ratio target to more than 10% under Basel III. Previously, the company had set a target in the range of 9.5–10.5%.

Our Viewpoint

HSBC is striving to boost its profitability in the challenging market environment by disposing unprofitable/non-core operations. The company now intends to primarily focus on mature economies such as the U.S., Germany, France and emerging economies including China, Indonesia and Brazil. Further, it seeks to strengthen its home operations in the U.K. and Hong Kong.

HSBC is poised to benefit from its extensive global network, strong capital position, business re-engineering and solid asset growth. Further, the company’s cost containment measures are expected to extensively help it in countering economic pressures. However, high inflation in some key Asian markets, sluggish loan growth, insufficient core operating performance and increased wage inflation will likely limit the company’s growth in the near term.

HSBC currently carries a Zacks Rank #3 (Hold). Some better performing foreign banks that are worth considering include Barclays PLC (BCS), Mitsubishi UFJ Financial Group, Inc. (MTU) and The Bank of Nova Scotia (BNS). All these stocks carry a Zacks Rank #2 (Buy).