HSBC shares extend rally to 13% but are still ‘cheap’

Banks will make more money if interest rates rise, but this global bank should shine even if they don’t.

Downtrodden HSBC (LSE:HSBA) shares look to be “very very cheap” if interest rates rise, a leading analyst said today after swinging behind the banking giant for the first time in years.

UBS's Jason Napier, who upgrades his rating from ‘neutral’ to ‘buy’, said the shares would still be cheap even if rates stay the same, having seen HSBC endure one of the worst performances in European banking this year.

The Asia-facing bank hit its low point for 2021 at 359p in mid-September, but Napier thinks there's a potential upside to 485p based on the near-term earnings prospects and potential for margins-enhancing rate rises.

Shares defied today's wider market gloom to rally more than 3% or 12.95p to 405.95p.

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HSBC has been on UBS's list of least preferred European banks since at least 2017, reflecting interest-rate headwinds, restructuring costs and a preference for more focused plays.

Napier said: “Now, however, at current levels and given the outlook, we think HSBC represents favourable risk-reward driven by a number of key factors, which individually would be material and combined make for a compelling case in our view.”

His chief reasons for buying the heavyweight stock include the potential for buybacks and special dividends after HSBC disclosed £5.5 billion in excess capital at the half-year stage. This could mean a $2 billion buyback to be announced at the third quarter results.

Napier also believes the market is undervaluing HSBC's growth potential, which is based on management's own stated target for 5% a year income growth.

Interest rate cuts have cost the bank 20% of profitability since 2019, so even a slight recovery in margins once rates start to rise next year should mean strong profit momentum for a bank of HSBC's size.

Even if rates don't rise, Napier is forecasting 10% pre-provision profit growth into 2022 due to the impact of cost and capital restructuring as well as the strong loan book quality.

HSBC's 50% share price underperformance since the middle of 2019 puts the stock at 8.2 times the City's forward earnings per share consensus, representing a 10% discount to the European banking sector average.

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Geopolitical risk and the lack of decent dividends during the period of Covid-19 have also reduced the appeal of a stock that accounts for about 4% of the FTSE 100 index and 11% of the European banking sector.

Investors may be fearful about contagion from the debt crisis at property giant Evergrande (SEHK:3333), but Napier sees concerns around HSBC's $6 billion exposure to mainland China real estate as overdone.

He added: “We think HSBC is the largest investor bank underweight in Europe: an issue if a discount valuation, turn in rates cycle, return to decent pay-outs and improved confidence around medium-term growth cause a shift in relative performance.”