Why I believe HSBC shares are a great buy now that the price has dropped

HSBC Holdings plc (LSE: HSBA) looks like a long-term cash cow that just got cheaper.

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With the bulk of its business concentrated in Asia, HSBC Holdings (LSE: HSBA) suffered relatively lightly from the banking crisis that afflicted the UK’s other FTSE 100 banks.

But while the likes of Lloyds Banking Group are getting back to healthy growth, HSBC shares have been falling back — over the past five years, Lloyds shares are up 42% while HSBC’s are actually down 1%. And since the start of 2018, it has been the worst performer with a fall of 9%.

HSBC has actually been through a tricky process of restructuring since the crisis. While nowhere near needing a bailout, it was a bit overstretched and undercapitalised, and it’s a significantly leaner operation these days — though not without pain.

Full year

HSBC’s 2017 results were hit by loan impairments rising to $658m, partly due to the collapse of Carillion. But revenue reached $51.4bn, from $48bn a year previously, and pre-tax profit soared from $7.1bn in 2016 to $17.2bn. Part of that improvement came from a strengthening retail division performance, and that’s pretty much where banks are looking these days to lower their risk and protect their balance sheets.

Analysts are forecasting a return to sustained earnings growth, and that should lead to a strengthening of HSBC’s dividend progress. We’re currently looking at a predicted dividend yield of 5.4% for 2018, which would be covered 1.4 times by earnings. That looks good enough to me, though it is below cover from Lloyds.

And HSBC is planning to return further capital to shareholders, after the bank completes its raising of alternative tier one capital through a new debt issue — which is to meet some arcane regulatory requirement. The tier one capital ratio stood at 14.5 at year-end, so there’s no real concern.

Tempting challenger

Whenever I’ve looked at Arbuthnot Banking Group (LSE: ARBB), I’ve always believed it to be a well-managed operation.

The challenger bank has been recording losses per share for the past two years, but the City’s experts appear to think it is on the verge of something special. From an admittedly low base, EPS is predicted to grow by 76% in 2018, followed by a further 75% the year after — which puts us in the unusual position of seeing attractive growth metrics in the form of very low PEG ratios, from a bank.

Before that we’ll have 2017 results on 28 March, and forecasts suggest EPS of around 46p per share — anything better than that, and I reckon we might see an uprating of the share price. As it stands, if results come in according to forecasts, Arbuthnot’s P/E would drop as low as 9.3 by 2019 should the share price remain unchanged.

Future health

I don’t think there’ll be any surprises in 2017’s figures, as the bank’s February pre-close update assured us that pre-tax profits should be in line with market expectations after it “continued to trade well in the fourth quarter of 2017.

We were also teased by the prospects of Arbuthnot diversifying by investing in the launch of new businesses in 2018, and I’ll be watching for further details.

At the moment, I think it’s clear that shares in the UK’s banks are still being held back by the uncertainties of Brexit, but the closer we get to clarity on the divorce, the more I think we’ll see how undervalued players like Arbuthnot really are.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alan Oscroft owns shares of Lloyds Banking Group. The Motley Fool UK has recommended HSBC Holdings and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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