We have upgraded our long-term recommendation on HSBC Holdings plc (HBC) to Neutral from Underperform, based on the success of its restructuring initiatives. The company remains on track to achieve cost savings of $3.5 billion by 2013 and streamline its operations as well as improve its top line.
However, for the first quarter of 2012, HSBC reported an approximate 34% drop in net income attributable to lower fee and dividend income. These were partially offset by increases in the net interest income and net trading fees. Moreover, we remain concerned regarding the negative impact of the deepening Euro-zone crisis, weak revenue growth in its mature markets and regulatory restrictions on the company’s financials.
Last year, HSBC announced its plans of restructuring the business with the primary intention of increasing focus on the fast-growing and profitable markets. As of May 17, the company announced the divestiture or closure of 28 of its businesses.
Some of the major divestitures completed recently include the sale of U.S. credit card business to Capital One Financial Corporation (COF) and 195 branches to First Niagara Bank, N.A., a unit of First Niagara Financial Group Inc. (FNFG).
Additionally, HSBC’s brand, capital strength and extensive global network enables it to attract and retain clients. In an effort to further enhance its competitive advantage, the company is trying to increase its emerging-market exposure. The company has also been taking advantage of higher-growth, lower-cost regions such as China and India, to set up major back-office operations, which are likely to boost the bottom line.
Also, continuously improving profitability ratios are a major positive for HSBC. In addition to that, the company has been able to remain profitable during the financial crisis, a time when many financial institutions suffered. In 2011, return on average equity and return on risk-weighted assets increased to 10.9% and 1.9%, respectively, from 9.5% and 1.7% in the previous year.
On the flip side, though HSBC has been reporting stable operating income over the last several quarters, growth in core business performance indicators, including net interest income and fee income has been unsatisfactory. We believe that it would be difficult for the company to sustain in a sluggish economy coupled with low interest rate environment and increased regulations.
Further, despite management’s efforts to lower costs, we believe that rising wage inflation in faster-growing markets and strategic investments will not allow HSBC to make the cost line favorable any time soon.
In the first quarter of 2012, though the underlying cost efficiency ratio improved to 55.5% from 58.7% in the prior-year quarter, it still remained substantially higher than the company’s target range of 48-52%. We expect that the re-engineering efforts undertaken by the company to lower costs, will take some time.
HSBC currently retains a Zacks #3 Rank, which translates into a short-term Hold rating.
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