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Futu Research | The latest financial report is out, what is the investment potential of HSBC Holdings?

In the investment community, there is a familiar saying from Hong Kong shareholders: “When the Christmas bell rings, buy HSBC shares”. This statement reflects investors' widespread recognition of HSBC's steady operation and continued dividend payment. Since 2012, HSBC has adopted a more flexible dividend strategy, changing the one-off dividend of the year to quarterly distribution. This adjustment has undoubtedly enabled shareholders to obtain return on investment more evenly, with real returns every quarter.

Now, let's thoroughly analyze the investment value of HSBC Holdings and combine the latest financial reports to give a detailed explanation from the two core dimensions of earnings per share (EPS) growth and shareholder return.

1. How should we split HSBC's performance

1. Revenue analysis: changes in the economic cycle and market interest rates directly affect the company's performance

HSBC Holdings Limited is a global banking and financial services institution headquartered in London, England, and is the parent company of the HSBC Group.

HSBC Holdings' revenue and profits are mainly driven by four core business segments, including retail banking and wealth management, commercial finance, global banking and markets, and private banking. Historically, the Asian region accounts for more than half of the business revenue, especially Hong Kong, China, and contributed greatly to the Group's overall profit. The profitability of the Asian market often had a significant impact on the overall performance of HSBC Holdings.

To make it easier to understand the profit models of various businesses, let's take a few examples to understand how HSBC makes money through these businesses.

① Deposit and loan business: HSBC accepts customer deposits and pays a certain amount of interest. Banks use these funds for lending or other investment activities to earn higher interest income.

② Credit card business: HSBC issues credit cards and charges the cardholder an annual fee, interest and other fees.

③ Investment banking business: HSBC provides investment banking services, such as stock underwriting, merger and acquisition consulting.

④ Insurance business: HSBC provides insurance products, such as life insurance, property insurance, etc.

Generally speaking, the analysis of HSBC depends on two things: revenue growth and business security. First, let's look at the revenue side.

2. The company's main business revenue mainly consists of two parts:

(1) Interest income and net interest income (NIM): As a bank, interest income is one of its main sources of revenue, including interest from loans, bond investments, etc. The net interest yield can reflect the bank's capital costs and lending efficiency.

(2) Non-interest income: including processing fees and commission income (such as credit card fees, financial service fees), investment banking revenue (underwriting, consulting, transaction commissions, etc.), asset management and insurance business income, etc.

Judging from historical data, the commercial bank characteristics of the revenue of HSBC Holdings are quite obvious.

① Net interest income generally contributed 50% to 60% of revenue, accounting for 54% in 2023, making it the most important revenue component;

② The share of net income from handling fees and commissions remains at the level of 25-30%;

③ The contribution of other income fluctuates greatly, mainly including transaction income, investment income, premium income, etc.

Therefore, the operating performance of HSBC Holdings will be affected by various factors such as the global economic environment, changes in interest rates, regulatory policies, market competition, and its own strategic adjustments.Among them, the impact of economic cycles and changes in market interest rates is the most direct: changes in interest rates directly affect banks' interest rate spread income, and a low interest rate environment may reduce profit margins; while economic growth affects customers' loan demand and ability to repay.

Figure: Composition of HSBC's main business

Material Source: Futubull

3. How are HSBC's costs and fees affected:

For large multinational banks such as HSBC Holdings, employee compensation and benefits expenses are ongoing and relatively large expenses, including basic wages, bonuses, benefit plans (such as health insurance and pensions), training and development, etc. At the same time, for HSBC at this stage, the cost of restructuring plans for various businesses is also an important factor affecting operating expenses.

Specifically for this quarter, the HSBC Group's operating expenses in 2023 fell by 600 million US dollars to 32.1 billion US dollars, mainly due to cost savings after the completion of the restructuring plan; however, increased compensation and technology costs offset some of the savings.

After excluding factors such as one-off projects (such as the acquisition of the Bank of Silicon Valley in the UK), exchange rate changes, and performance adjustments in hyperinflationary economies, operating expenses under the target benchmark increased by 6%.

II. How profit is expected to change

1. Fourth quarter results: The sharp decline in profits was mainly impacted by non-recurring projects

HSBC's financial results for the fourth quarter of '23 declined markedly. Compared with the same period last year, profit before tax fell sharply by US$4.1 billion to US$1 billion. Mainly because non-recurring projects had a big impact on current profits:

First, it confirmed the US$3 billion impairment fee associated with the investment affiliate BoCom;

Second, due to preparations to sell the retail banking business in France, it was reclassified as an asset for sale, and impairment losses were calculated for this.

In terms of main business revenue, after deducting the impact of this one-time incident, the report indicates that revenue in the global payment solutions, capital markets and consulting businesses, and the market and securities services (MSS) sector has increased, which indicates that its core business revenue is relatively stable or showing a positive trend. However, due to the negative impact of the sale of retail banking business in France and related disposal activities, overall revenue fell 11% to $13 billion.

2. The performance of net interest income determines performance.

Net interest income: The size of the deposit and loan multiplied by the net interest spread can be understood as a rough estimate of the bank's potential net interest income. NII ＜ NIM × total average interest-bearing assets, NIM == return on interest-bearing assets - interest-bearing debt cost ratio.

(1) Net interest spread (NIM): A month-on-month decrease of 18 basis points to 1.52%, which indicates that the yield gap between bank interest-bearing assets and interest-bearing liabilities narrowed during the quarter. Taken apart, the yield on interest-bearing assets increased 135 basis points to 4.90% year-on-year, and the cost ratio of interest-bearing debt increased 162 basis points to 3.83% year over year, mainly due to the impact of the interest rate environment during Q4. Changes in interest spreads in the banking industry are linked to interest rate performance.

(2) Total average interest-bearing assets: Positive performance exceeding market expectations.

Total customer loans increased 1.6% year over year, and total deposit amount increased 2.6% year over year.

Looking at the overall situation, net interest income is highly linked to changes in the interest rate cycle (benefiting from weak financial performance during the interest rate hike cycle and interest rate cut cycle). The figure below is a very typical reflection of this trend.

Figure: Earnings per share and growth rate

Material Source: Futubull

In summary, net interest income is the company's main source of profit, and its decline puts pressure on the company's overall performance. The probability of performance growth in 2024 will depend on changes in the interest cycle.

III. What is the expected return on investing in HSBC

There is a saying in Hong Kong: “Christmas bell, buy HSBC”, which means if you buy HSBC shares before Christmas arrives, you can sit back and wait for the dividends. Since 2012, HSBC has also distributed dividends into four installments until the end of the year. Generous shareholder returns are an important reason why many investors love their shares. Shareholder returns can be divided into two levels. One is a dividend; it is a repurchase.

(1) Dividends distributed in 2023: $11.593 billion plus the fourth dividend in 2023 of $5.913 billion, for a total of $17.506 billion.

(2) 2023 repurchases: Three share repurchases totaling US$7 billion were carried out in 2023.

As a result, the overall shareholder return was US$24.5 billion. If HSBC was purchased at the end of 2022 (US$126.367 billion), the company's dividends and repurchases alone would have a return of 20%.

Figure: Dividend Payout Situation

Source: Company Announcements

In the last quarter's earnings report, management mentioned that the bank is still considering a special plan: if they successfully sell the Canadian banking business and receive payments in the first half of 2024, they will prioritize using part of this capital to pay an additional special dividend of $0.21 per share to each shareholder.

As far as the dividend rate is concerned, the bank plans to distribute half of the profits to shareholders as dividends in the next 2023 and 2024. However, when calculating the dividend ratio, some special one-time event benefits (such as proceeds from the sale of French retail banking business, agreement proceeds from the upcoming sale of Canadian banking business, and temporary value added from the acquisition of the Bank of Silicon Valley in the UK) are not included. The revenue from the company's main business is one of the key factors in determining dividends.

In recent years, the comprehensive dividend rate has been around 50%. If you buy HSBC Holdings today (market capitalization is about US$145.2 billion), without considering the special dividend, the dividend rate for 2024 will be around 8%.

Repurchase amount: The management promised to launch a share repurchase of up to US$2 billion. The share repurchase is expected to be completed before the announcement of the results for the first quarter of 2024.

Dividends plus the repurchase ratio, and the overall shareholder return is around 10%.

Therefore, for HSBC shareholders, changes in stock prices are linked to the interest rate cycle. If interest rates continue to be high in the later stages, the HSBC net spread can be maintained or even widened, and investing in HSBC is likely to achieve more than double digit returns.

The risk is that the overall economic situation is declining, and there is a cycle of large interest rate cuts. At this time, HSBC's overall valuation capacity and shareholder returns will be seriously adversely affected.

We can think that investing in HSBC = investing in the overall economic situation where HSBC does business. For investors, predicting the local situation will be an important basis for investing in HSBC.

$HSBC HOLDINGS (00005.HK)$

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