May 3, 2019 / 9:56 AM / 19 days ago

Breakingviews - HSBC’s rich valuation reflects spare buyback ammo

A logo of HSBC is displayed outside a branch at the financial Central district in Hong Kong, China June 2, 2015. REUTERS/Bobby Yip

LONDON (Reuters Breakingviews) - HSBC’s first-quarter results shore up its rich valuation. The global bank reported a robust 10.6 percent return on tangible equity in the first three months of the year, buoyed by a lending spike. Investors were already assuming that the bank hits its 2020 return targets. Potential for more buybacks in the second half provide additional firepower.

Chief Executive John Flint repaid shareholders’ faith in him – and then some – following last year’s bruising fourth quarter. At the time he pledged to grow revenue faster than costs. First-quarter results delivered. HSBC’s adjusted revenue expanded by an impressive 9 percent, year-on-year, while operating costs rose by just 3.2 percent.

The income boost was driven by trade-linked commercial banking and retail lending, both of which delivered a tenth more revenue than in the same period of last year, confounding worries about China-U.S. trade tensions and an economic slowdown in China. True, the perennial bugbear of what to do with HSBC’s subscale and low-returning American operation remains: Flint described it as the bank’s “most challenging” strategic priority. But at least HSBC can draw on other sources of strength as it attempts to lift the division’s lacklustre return on tangible equity towards a modest 6 percent target next year.

Following a 2.5 percent jump on Friday morning HSBC shares are now valued at nearly 1.3 times the bank’s tangible book value at the end of March, making it one of the only large European lenders to trade at such a premium. Assuming a cost of capital of about 10 percent, that implies investors already take a targeted 11 percent return on tangible equity next year as given. That seems sensible. If HSBC’s revenue grows at a more conservative 4 percent a year and costs rise by 1.5 percent, Flint will surpass his goal, according to a Breakingviews calculation which uses a 22 percent tax rate and projected tangible book value of $160 billion.

Returning excess capital further underpins HSBC’s valuation: the bank’s common equity Tier 1 capital ratio is 14.3 percent, giving it a spare $2.6 billion or so to spend buying back shares. Flint said the bank would make a decision in the middle of the year. On these results, investors’ faith looks likely to be repaid.

Breakingviews

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