During 2006, at the height of the pre-financial crisis boom, HSBC‘s (LSE: HSBA) (NYSE: HSBC.US) shares hit 1,000p, a level not seen since the dotcom bubble.
However, since then the bank’s shares have stayed below 800p, even though HSBC is now in better shape than it was when the financial crisis set in. The question is, will HSBC’s shares ever return to 1,000p, or will they languish below 800p for the rest of the decade?
Strong recovery
HSBC has made one of the strongest recoveries in the banking sector after the financial crisis.
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Luckily the bank, which does a large part of its business within Asia, escaped the majority of the crisis, although the widespread carnage caused by the crisis did impact HSBC’s balance sheet. The bank undertook a £12.5bn rights issue during 2009 in order to bolster its balance sheet and avoid any further cash calls.
HSBC is now prudently managing its capital position and the bank’s core tier 1 capital ratio — financial cushion — is one of the best in the industry, standing at 11.3%, up from 10.8% as reported at the end of 2013. This capital position is only likely to get stronger. HSBC generated profits of $12.3bn during the first half of this year, making HSBC one of the world’s most profitable businesses on a dollar basis.
Further, HSBC’s pre-tax profits have rapidly rebounded over the past five years, growing 218% since 2009. However, the bank’s growth is now about to slow.
Struggling for growth
Most of the HSBC’s earnings growth since the financial crisis has come as a result of cost cutting, rather than sales growth. According to my figures since 2009 HSBC’s operating income has dropped from £41.8bn, down to £40.8bn as the bank shrinks its balance sheet and pulls out of risky markets.
Still, cost cutting has provided meaningful earnings growth. Since taking the position three years ago, Chief Executive Stuart Gulliver has sold or closed around 60 of HSBC’s businesses. Additionally, 40,000 jobs have been axed and costs have been slashed. Over $5bn was wiped of HSBC’s operating cost bill during 2013 alone.
But now HSBC is struggling to cut costs, in fact costs are rising, as the bank struggles with an ever increasing amount of regulation and legal paperwork. Indeed, management has estimated that the bank will spend $750m to $800m this year on its compliance and risk programme, an increase of around 25% on last year’s figure.
Costs are expected to increase by a similar amount again next year and of course, these costs exclude one-off charges. Within the last few days HSBC has estimated that the UK rules forcing banks to ring-fence retail and institutional banking activities will cost the group approximately £2bn.
Unfortunately, these rising costs are now threatening HSBC’s growth as they start to eat away at profit margins. Rising compliance costs pushed HSBC’s operating expenses up by a total of 4% to $18.2bn during the first half of this year.
As a result, the bank’s cost efficiency ratio ticked up to 58.6% from 55.3%, above management’s targeted mid-50s level, erasing much of the cost cutting work done over the past three years or so.
The bottom line
All in all, HSBC’s shares will struggle to move higher over the next few years, as costs rise and the bank finds it difficult to expand income. Than being said, for income seekers HSBC is a great pick as the bank currently supports a dividend yield of 4.9% and the payout is covered 1.7 time by earnings per share.
