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Sell HSBC (HBC)
07/13/2011 3:00 pm EST
It’s one of the great global franchises in banking with strength in exactly the part of the world—developing Asia—that you want in a bank stock over the next decade.
But over the last decade the bank lost its way, I’d argue.
The most obvious sign of that was the bank’s acquisition of Household International, the second largest U.S. subprime mortgage lender, for $15.5 billion in 2002 just in time to catch the U.S. mortgage crisis. By the time the bank had wound up that business losses just about equaled the original acquisition price. That deal wasn’t just a bit of bad timing though. It represented a curious decade-long quest to grow the bank in the world’s developed economies through acquisitions in France, the United States, and the United Kingdom. I’ve never heard a convincing argument from HSBC about why a bank with a leading position in the world’s fastest growing economies would decide to spend investors’ money expanding into the world’s slowest growing economies.
At the end of 2009 Europe accounted for 54% of assets and North America 20%, and emerging economies for just 17% (Hong Kong), 9% (the rest of Asia), and 5% (Latin America.)
Stuart Gulliver, the new CEO who took over in January, has announced a turnaround plan that would temper these global ambitions. But the strategy can’t by any means be called one of returning to the company’s roots in Asia.
Yes, the bank has targeted wealth management, particularly wealth management in Asia as a focus for growth. Gulliver expects to generate $5 billion in additional revenue from that sector.
And he did say, “We’ve tried to do everything, everywhere, always. We’re not going to do that anymore.”
But the bank hasn’t exactly decided to abandon its drive into developed economies. HSBC will either wind down or sell off its U.S. credit card business and scale back its U.S. retail banking operation but it still wants to be a major corporate bank in the United States. And when Gulliver listed markets where the bank thought retail banking made sense for HSBC he listed both developing economy Hong Kong and mature market the United Kingdom.
For investors going forward I think the question that HSBC’s strategy poses is pretty simple: Is there some reason that owning shares of a bank with global scale will offer a better return—adjusted for risk--than owning shares of a more narrowly focused developing-economy bank?
On the growth numbers I think the answer is No.
HSBC has grown revenue by an annual average of 5.12% over the last five years and by an annual average of 12.36% over the last ten years.
In comparison a “pure” developing economy bank like Brazil’s Banco Bradesco (BBD) shows average annual revenue growth of 8.31% over five years and 17.62% over 10 years. At what I’d call best of class developing economy banks such as Brazil’s Itau Unibanco (ITUB) or India’s HDFC revenue growth over the last five years comes to an annual average of 20.63% and 38.59%.
On the risk numbers I think the answer isn’t much better than Maybe.
What you do get with a global bank such as HSBC is far less exposure to single-country risk. Itau Unibanco will rise and fall with interest rates, GDP growth, and inflation in Brazil. HSBC’s business is spread over the world so that, under most financial scenarios, bad news in the United Kingdom can be offset by good news in Hong Kong. Of course, there are the unusual financial scenarios, such as the global financial crisis, in which most markets fall in lockstep, and instead of global diversification offering an investor a way to offset losses in an individual market, a global bank offers you a chance to lose money in a wider variety of markets.
But even this may need a caveat in the world where developed economy finances are, by and large, shakier than developing market finances. What kind of risk-reducing diversification do you get over the next ten-years if your business is split among the-likely-to-face-credit-rating-downgrade countries of the United States, the United Kingdom, and Japan versus the-likely-to-be-upgraded-economies of Columbia, Brazil, and Chile.
There’s no doubt that HSBC’s business is more diversified than that of Itau Unibanco but what’s the value to an investor in shares of a company that’s diversified over slower growing and more risky markets?
My judgment is not that HSBC is a bad stock—you might even do well on the company’s recovery since I calculate that once the banking sector returns to something like normality a 12-month target price of $60 (about 20% above the recent price) is reasonable for these shares.
But I don't think normality for bank stocks is just around the corner and when it does come into sight I think other stocks in the sector, with more developing market exposure, will be better stocks for the long run.
So what should you do? It depends on your read on the environment for bank stocks over the next six months or so. If you think the sector is about to return to normality, then hold on. But if you think, as I do, that there's a lot of potential bad news hanging around out there--from not-so-positive second quarter earnings reports to the higher capital requirements of the Basel III regulations to the continuing debt crises in Europe and the United States--then I think the best strategy with these shares is to sell now and reduce your exposure to those risks--and then re-evaluate this and other bank stocks in the fall.
As of July 13 I’m selling these shares out of my Jubak’s Picks portfolio http://jubakpicks.com/ with a 14.7% loss since I added them on December 15, 2009.
Full disclosure: I do not own shares of any stock mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of HSBC as of the end of March. The fund did own shares of Banco Bradesco, Banco Santander, HDFC Bank, and Itau Unibanco as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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