Wednesday, April 12, 2006

WSJ Article on HSBC

  
The Wall Street Journal, Dimitra Defotis, 13 April 2006

HSBC Holdings is building a string of pearls in the ocean of global finance.

But the global bank may not be getting its due in the stock marketplace. In the past year, the stock is only up 6%, underperforming the Standard & Poor's 500 index and moving only slightly ahead of rival Citigroup.

That performance, however, may reflect investors' narrow focus on the possible negative impact of rising interest rates on HSBC's U.S. operations, not the gem of a business it has created globally, especially in emerging markets.

That's why the stock could end up being a solid performer in the coming years. And investors get a juicy 4.3% dividend yield while they wait.

"This stock is a jewel that needs a little bit of polishing," says Reiner Triltsch, who owns the stock in the U.S. Trust Excelsior International Equity Fund. "I see good management, good geographic diversity, a good dividend, and 6% earnings growth that could be 10%."

Sir John Bond, HSBC's departing chairman, helped solidify HSBC's North American business, which accounts for a third of earnings. That matches earnings from Asia, where the former Hong Kong & Shanghai Banking Corp. got its start in 1865.

Measured by market value, HSBC is the third-largest bank globally, behind Citigroup and Bank of America. Emerging markets are roughly 15% of earnings, and HSBC expects growth from places like Mexico, Brazil, Turkey and China to boost profits.

Despite ramped up spending on investment banking globally, HSBC's performance last year was the best in nearly a decade: organic revenue growth of 10% and pretax profits of roughly $21 billion.

Roughly half of profits came from personal financial services -- deposits, loans and credit cards globally. Commercial banking and corporate investment banking each produced roughly a quarter of profits.

HSBC has 125 million customers in 76 countries and territories, but still holds court in Hong Kong, which contributed 21% of last year's profits. North America and Europe each accounted for roughly a third of earnings.

Despite this diversity, investors have focused on the consumer lending business of HSBC Finance, formerly Household International. As one of the largest providers of subprime home-equity loans in the U.S., it exposes HSBC to payment defaults as interest rates rise.

But with U.S. short-term interest rates likely to peak in the second half of 2006, net interest margin pressure should subside, writes Nomura International analyst Kevin Chan.

Douglas Flint, HSBC's finance director, says rate increases have been gradual and "unless you get an abrupt change in the economy...you adjust pricing."

HSBC shares, about 3% from their 52-week high, are roughly 11% since Barron's favorable article (see Barron's, "World Beater," Aug. 9, 2004).

Given "the best underlying growth and operating 'jaws' since the Asian crisis," Citigroup analyst Simon Samuels upgraded the shares to Buy in March.

And that's despite management change. Stephen Green, HSBC's chief executive, becomes chairman in May. Bond, 64, is leaving HSBC after 45 years, eight as chairman, to head telecom giant Vodafone.

Under Bond, HSBC maintained its reputation for conserving capital. With more cash on the books, HSBC has been able to pounce on good deals, says Alastair Ryan, an analyst at UBS in London.

Those include the 2003 purchase of Household for $14.5 billion and the 2002 purchase of Grupo Financiero Bital (now HSBC Mexico) for $1.2 billion.

"HSBC is always criticized in good markets for having too much cash sitting around, but you don't want banks leveraging up to make acquisitions," Ryan says.

Flint says that big acquisitions are not on the radar screen for 2006 because "it is difficult to see what the value proposition would be." But he expects emerging markets, improvements in Europe and expansion in the U.S. to drive profits.

Another advantage: HSBC has invested some $5 billion in China, setting it apart from other major banks for its early entry and influence. Its 20% stakes in two large Chinese financial enterprises, Ping An Insurance and Bank of Communications, have appreciated roughly 150%, Ryan estimates.

Shares of HSBC are trading at 11.4 times 2006 earnings, in line with Citigroup's multiple. And even if the price-to-earnings multiple doesn't return to higher historic averages, strong earnings should boost the share price.

HSBC is "executing well on a strategy to better sell products within its footprint, and the multiple has gone the other way," Ryan says. "They have accelerated revenue growth without hurting margins."

Of course, HSBC may be missing out on growth opportunities by waiting for acquisition price tags to fall.

And if the global economy falters, HSBC would suffer, too.

But HSBC is uniquely positioned to offer banking services to European and American customers doing business in emerging markets, and can also offer credit cards, loans and more to the rising middle class in those markets.

And while those opportunities may look as lumpy as freshwater pearls today, they are sure to produce handsome returns for long-term investors.
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