Successful businesses rarely stray too far away from the core activity which made them great — and when they do, the results are often underwhelming.
Take HSBC Holdings (LSE: HSBA) (NYSE: HSBC.US): it remains successful today because it has stayed true to its role as a large Asian bank with strong links to the UK.
Where HSBC has strayed from its historical roots, the results have sometimes been underwhelming; becoming known for its role in laundering Mexican drug money was probably not HSBC’s finest hour.
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When analysing HSBC’s appeal as an investment, we tend to focus on HSBC Holding’s results. However, HSBC Holdings isn’t a bank — it’s a group of banks, each of which represents HSBC in different parts of the world.
This one really matters
In 2013, HSBC reported pre-tax profits of $22.6bn. Of these, no less than 70% ($15bn) came from Asia-Pacific. The vast majority of these were generated by the founder member of the HSBC group, The Hongkong and Shanghai Banking Corporation Limited.
I suspect that few HSBC shareholders are dedicated enough to look at the individual results from this bank, but if you are, you will see why it makes such good sense for HSBC to trim its non-core and small scale operations and focus on its core markets:
| HSBC Holdings plc | The Hongkong and Shanghai Banking Corporation Limited | HSBC Bank plc [HSBC’s UK business] | Barclays | |
|---|---|---|---|---|
| 2013 pre-tax profits | £13.6bn* | £11.0bn* | £3.3bn* | £2.9bn |
| Cost-efficiency ratio | 59.6% | 33.9% | 66.8% | 79% |
| Common Equity Tier 1 (CET1) Ratio | 10.9% | 14.1% | Not provided | 9.3% |
| Return on average shareholders’ equity | 9.2% | 25.9% | 7.9% | 4.5% |
*These don’t sum correctly due to currency effects and the complexities of HSBC Holdings’ finances.
As you can see, shareholders in The Hongkong and Shanghai Banking Corporation (i.e. HSBC Holdings shareholders!) are invested in a fine business. Capital strength is good, with a CET1 ratio of 14.1% — higher than any of the big UK banks — while profitability is outstanding, as shown by a return on average shareholders’ equity of 25.9%!
One reason for such high profitability is that the bank’s cost efficiency ratio is very low, at 33.9%. Low costs mean that more income passes through to the bottom line, and this is something that many UK banks — including HSBC and Barclays — are struggling with, as the figures above show.
Single point of failure?
The figures above highlight how HSBC Holdings depends on its Asian operations for the majority of shareholder returns. They also indicate how many of the group’s smaller business are underperforming, dragging down overall returns.
It makes good sense for HSBC to continue to selectively cull some of these smaller operations, and in time this should help improve the group’s returns on equity, and support strong dividend growth, adding to the powerful buy case for this global bank.
