Must read: HSBC, Diageo, IAG

HSBC – Wednesday 25 February 

HSBC Holdings (LSE:HSBA) rounds off the UK banks’ reporting season after a messy third quarter which should even out somewhat for the year as a whole.

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At that time, the headline pre-tax profit of $7.3 billion (£5.4 billion) was 14% lower than the previous year, with a number of provisions in play, including a $1.1 billion provision for a lawsuit relating to Bernie Madoff and a previous $2.1 billion charge for its losses related to its Chinese Bank of Communications stake was also a headwind. For the third quarter, a further impairment charge of $1 billion included some pressure from its exposure to the Hong Kong commercial real estate sector.

The news was hot on the heels of the announcement that HSBC would be buying the remainder of Hang Seng Bank which it does not already own for an estimated $13.6 billion, or £10.2 billion. However, in order to finance the acquisition, HSBC also announced that its share buyback programme would be suspended for at least three quarters, leading to a dip in the share price alongside some questions on whether this was the best use of excess capital, despite payments of the dividend, which currently yields 3.8%, being unaffected. 

For all the noise, there is also evidence of growing success for its strategic plan, which is significant but simple. Whereas HSBC had been moving towards becoming a business with a slavish reliance on interest rate movements and levels, the revised and increasing focus on the growth in affluent wealth, especially in Asia, is key to the new offering. The group has been investing heavily in this move, giving HSBC higher, but more diversified income streams. 

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Apart from the longer-term potential for the key Chinese market, the group previously identified areas such as India and Vietnam as being some of the fastest growing economies at present, while the building economic connections between Asia and the Middle East, notwithstanding any geopolitical conflicts, are also emerging opportunities for HSBC with its sprawling footprint. Investors have been keen to acknowledge this explosive potential, with the shares having risen by 44% over the last year and by 99% over the last two years.

Diageo – Wednesday 25 February 

Investors have found Diageo (LSE:DGE)’s recent performance difficult to swallow, with the shares having dropped by 17% over the last year and by 50% over the last three years. That being said, there are emerging glimmers of hope given the reach and power of the group’s brand portfolio and the recent appointment of ex-Tesco and Unilever stalwart Dave Lewis as CEO was positively received.

It remains to be seen whether the concerns overhanging the sector as a whole are cyclical or societal. There is some evidence of customers trading down to cheaper alternatives, which provides an immediate headwind to Diageo’s premiumisation aspirations.

Meanwhile, there is some debate as to whether the younger consumer market is a growth area at all given changing attitudes, although the growing proliferation of the “moderation”, low to no-alcohol drinks could provide an opportunity. In addition, the pandemic “drink at home” boom has long since subsided, on top of which some are questioning whether the exponential growth in weight-loss drugs is a contributing factor to falling sales.

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More broadly, the current effects of US tariffs are likely to cause an annualised hit of some $200 million (upgraded from a previous $150 million) on profits although the group estimates that its mitigating actions, such as increasing prices, cost control and supply chain management will limit the damage. In addition, extended alcohol restrictions in China appear to be having an impact.

To this end, Diageo previously announced the beginning of its “Accelerate” programme which, inter alia, seeks to create a stronger operating model by delivering around $3 billion of free cash flow this year, alongside some $625 million (increased from $500 million) of cost savings.

In terms of performance, the jewel in the crown remains the Guinness brand. Apparently exempt from the concerns seen elsewhere by geography, habits or price, the stout produced sales growth of 12% last year, with double-digit hikes established for the fifth consecutive year. Guinness also gained share in its three largest markets, while the availability of a no-alcohol version has opened up an entirely new potential area of growth. It is therefore of little surprise that the group was quick to quash any previous rumours that the brand was being prepared for a spin-off. 

For now, risks remain with improved demand from US consumers a key part of any recovery. That being said, a forecast dividend yield of 4.3% is paying shareholders to be patient, with a sum-of-the-parts valuation estimated at over £22 per share (current price £17.60) likely to keep investors interested.

IAG – Friday 27 February 

The environment was a difficult one for International Consolidated Airlines Group SA (LSE:IAG) in the third quarter, with geopolitical uncertainty resulting, for example, in a reduction of capacity at Tel Aviv airport. In addition, the inconsistent performance of sterling added foreign exchange headwinds, while the government shutdown in the US let alone the ongoing trade wars and the UK Budget did little for the customer propensity to spend. 

However, figures for the year as a whole should emphasise that the third quarter was something of a minor headwind. Revenues could have grown by 4.9% this year and operating profit by 18%, while the €1 billion (£870 million) share buyback programme is all but complete. In terms of shareholder returns, an increase to the dividend led to a fairly pedestrian projected yield of 2.1%, with further announcements on the strategy to come with these results.

IAG had previously noted that while there was some pressure on economy flights to the States, the strength of its premium cabin offering had more than offset any weakness although demand has weakened of late. By brand, British Airways remains the star performer in terms of the group’s highest returns, especially this North Atlantic market which accounts for 32% of capacity. Flight frequency to selected destinations is continually on the increase, with IAG looking to maximise income from not only its premium offering but also an affluent customer base.

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Of course, the ferocity of competition and economic pressure remain as potential headwinds, as do some of the other issues which have historically blighted the sector, such as virus outbreaks, industrial action, volcanic dust clouds, higher fuel costs and technical outages at certain airports. Alongside the current macroeconomic and geopolitical concerns, this can be a potentially dangerous mix, underlying some of the potential hazards of investing in the airline sector. 

Even so, the arduous reparation from the ravages of the pandemic are all but complete, with the shares now having recovered to the record highs achieved in 2018. Investors who chose to buy in to the recovery while the shares were grounded have been handsomely rewarded, with the price having risen by 32% over the last year, and by 206% over the last two years. The group’s superior diversity of brands, price points and destinations lead to a sector-beating market consensus for the shares.