08 May 2006

Credit Suisse on HSBC

The Standard, May 08, 2006

Shares of banking giant are expected to keep climbing thanks to a weakening dollar and QDII, writes Lee Yuk-kei

HSBC Holdings, whose shares have recently emerged from a year-long stagnation, has regained its shine on the back of the Qualified Domestic Institutional Investor - or QDII - regime, the weakness of the US dollar with a relatively lower valuation than its peers and a share price that has lagged the broader market.

The shares of HSBC Holdings led the Hong Kong stock market rally last week despite the fact that what is being seen as a big positive in the bank's future, investment in Hong Kong by the mainland's National Social Security Fund, has not yet occurred.

The fund, the first mainland institutional investor given the green light from Beijing to invest overseas, is not yet ready to do so.

Shares of HSBC Holdings surged to HK$137.20 from HK$132.20 on the last trading day in April, coupled with massive buying orders of more than HK$10 billion last week.

The surge in HSBC shares came after the National Social Security Fund announced that it will be allowed to invest up to 20 percent of its assets in overseas stock, bond and money markets.

Given that the fund's total assets were worth 201 billion yuan (HK$194.5 billion) at the end of 2005, the estimated amount available for overseas investment should be 40.2 billion yuan.

KGI Securities reckons the amount the National Social Security Fund could invest in Hong Kong ranges between some four billion yuan and 6.4 billion yuan.

But since the fund can invest in other products such as global equities, US equities, global bonds and foreign exchange instruments, the total 6.4 billion yuan may not solely be invested in Hong Kong.

And as the benchmark for the fund's return on investment in Hong Kong equities will be the FTSE, the total amount invested in the local stock market will not only be in H shares.

As a result, the benefit to H shares from fund investments will be smaller than expected.

"We believe the fund will buy those Chinese shares that are not available in the domestic equity market, such as banks, insurance and telecommunication," KGI Securities said.

"Besides, some blue chips of good quality and with overseas business such as HSBC Holdings ... will also be Social Security Fund targets."

In addition to the boost from QDII, analysts said the resurgence of the euro and the pound sterling will help lift HSBC shares as the global bank derives about a third of its profit from Europe.

Core Pacific-Yamaichi banking analyst Kent Yau said the weakening of the US dollar against a strengthening pound and euro will boost HSBC profits from the European and United Kingdom markets and will also book translation gains from foreign exchange.

In the face of expectations that US interest rates will peak in the first half of this year and speculation that central banks sitting on mountains of foreign reserves will dump US dollars and replace them with other currencies and precious metals like gold, the US dollar has been weakening against the euro as well as the pound since early this year.

The pound has risen more than 7 percent to about US$1.85 from about US$1.72 since early this year. The euro has also soared more than 7 percent to about US$1.27 from US$1.18.

DBS Bank treasury and markets vice president Mark Wan Chuck-pui said he expects the dollar to hit US$1.29 per euro by year's end.

If the expected 25-basis point interest-rate hike [in the US] Wednesday is the peak, he said the US dollar will fall.

"On the other hand, in the face of mounting inflation pressure, low unemployment rate and strong economy, the European Union central bank is facing mounting pressure to raise interest rates," Wan said.

"So far the EU central bank has merely lifted its rate to 3.5 percent from 2.5 percent, compared with the US Federal Reserve which has raised its funds target rate to 4.75 percent from 1 percent since June 2004.

"Therefore, there's more room for Europe to raise interest rates at a very fast pace."

A Credit Suisse research report on April 25 said Europe is a difficult market for HSBC, particularly the UK, with competitive pressures on margins, rising consumer credit costs, a high share of investment expenses in capital and investment banking market business and investment in reducing a cost structure that is relatively high.

Credit Suisse forecasts HSBC's pre- tax profit will grow at an average 15 percent over the next three years on benefits from cost cuts, a more stable credit outlook and less investment spending in CIBM and in rebranding in France.

Credit Suisse set HSBC's target price at HK$168, representing an almost 22 percent upside potential from HK$137.2 at close last Thursday.

"We have shown that HSBC is trading on low multiples relative to history and relative to its international peers at present," said Credit Suisse analysts in the report.

"We believe that the stagnation in the share price [of HSBC] may be nearing an end, and when it does, the potential upside is considerable.

HSBC trades at just 10.9 times over its 2007 estimated earnings - a 10 percent discount to its UK peers.

HSBC ranks as one of the lowest- multiple major bank franchises in the region: multiples below those for South Korea's Kookmin Bank, all Singapore banks, Thailand's Kasikornbank, Indonesia-based Bank Central Asia, most Taiwan banks and all China-listed banks."

HSBC Holdings recorded a net profit of US$15 billion (HK$117 billion) in 2005, up about 15 percent from US$12.9 billion a year previously, driven largely by a strong performance in emerging markets, resilient trading revenues, low credit costs and cost controls in lower growth markets.

Moreover, the share price of HSBC Holdings has risen by 10 percent since January 2005.

In stark contrast, the Hang Seng Index has risen about 25 percent to above 17,000, while the MSCI World Finance Index has surged more than 20 percent.

Kent Yau of Core Pacific-Yamaichi said HSBC is a "defensive play" with a balanced global portfolio but its share price lags far behind peers such as Standard Chartered.

He estimates HSBC shares will hit HK$153 within a year.