November 12, 2009

HSBC (Buy, TP=820.0p) - Rating upgrade - US burden easing and Asian recovery accelerating – upgrade to BUY (8p)

Please find below our latest publication:

HSBC (Buy, TP=820.0p) - Rating upgrade - US burden easing and Asian recovery accelerating – upgrade to BUY (8p)

The US Finance division, which has been the group's Achilles' heel, booked much lower impairment charges in Q3 (35% lower than peak in Q4 08) and even surpassed HSBC's expectations. Elsewhere, asset quality in Asia and Latam is not an issue in our view, with impairment charges also falling in those geographies. Asia is showing signs of recovering and HSBC reported positive lending growth in the region, offsetting continuing pressure on deposit margin spreads. A core tier 1 ratio of 9% re-establishes HSBC as one of the better capitalised banks in Europe and the reversal of the AFS deficit from $18bn to $14bn should further enhance the group's capital position.

We have upgraded our earnings estimates by 8-13% for 2010/11 driven by a number of factors. Improving asset quality in the US and the absence of deterioration elsewhere should imply lower impairment charges in the near term. We are lowering our PFS US impairment charge by c.20% by 2011e. Although not immediately impacted, we expect an improvement in net interest margin from 2011 onwards as we estimate HSBC's margin is close to its trough in relation to the liability side of the balance sheet. Note that we remain cautious as we assume only moderate improvement, nowhere close to the recent peak in 2007. Looking elsewhere, we expect HSBC's investment banking division to perform in line with European peers despite its strong presence in Asian IB where economic growth could return the soonest in our view.

Target price & rating
We raise our TP by 20% from 680p to 820p on the back of (i) our earnings upgrade (c.10%); (ii) $/£ movements; and (iii) a lower cost of equity and higher growth given the improving outlook. At our TP, the implied P/TB is 2.1x 2010e vs 1.6x for Euro banks, a ratio we regard as undemanding given management's target ROE of 15-19%. A premium valuation is warranted in our view given HSBC's strong capital position, liquid balance sheet and genuine diversification in both geography and product mix – all without government support.

Next events & catalysts
HSBC will present at SG's Premium Review on 2/3 December

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