HSBC is well placed for future growth

Oct 6 2008 by Iain Laing, The Journal

HSBC has outperformed the UK banking sector by 35% since the start of 2008, despite the fact that it now represents more than half of the sector by market capitalisation.

It is also the only UK bank to have a total return in positive territory over the last 12 months. This is despite a number of problems at its US operations relating to the current sub-prime woes and the consumer slowdown. However, with HSBC’s emphasis on emerging markets, and the faster growth rates being witnessed in these regions, we believe it is better positioned than many of its global competitors for growth over the next several years.

Furthermore, the group’s strong capital ratios and surplus liquidity position continue to give it a defensive quality that global investors are still prepared to pay a premium for in the current operating environment.

Despite challenges in the US and signs of deterioration in its core Hong Kong market, we continue to believe that the prudence of its management, its solid balance sheet, good presence in growth markets and high level of diversification are reasons to continue to own the stock at these times, rather than lock in the relative outperformance.

Our estimate of fair value, based on a relative valuation measurement, is raised to 1000p, a reflection of the value investors are placing on low leveraged, strongly capitalised banks. We reiterate our Outperform recommendation.

Prudential - We are retaining our Outperform recommendation on Prudential, which is our preferred play in the UK FTSE Life Insurance sector. The Asian franchise remains the key attraction, where growth remains robust despite the economic difficulties faced in the West.

The volatile markets have impacted on the group’s strong variable annuities business in the US, but this has been counterbalanced by growth in fixed annuities. In the UK, the large with profits book has in fact benefited from market volatility, and the group has re-entered the bulk annuity market.

The group’s capital position is robust, despite a 4% fall in EV for the first half, and as policy books in Asia mature, group cash flow continues to improve. Although some were slightly disappointed by the half year dividend increase, the improving cash flow bodes well for dividend growth in the medium term.

The group currently trades at around Embedded Value and at a notable discount after removing the asset management division. This is clearly at odds with the group’s superior growth prospects in the Far East.

Andrew J Miller - Barclays Wealth- Regional Centre Head