HSBC (HBC): Adrian Day banks on global gains

“HSBC (NYSE: HBC), one of the world’s top banks, has come under attack recently by New York-based activist investor Knight Vinke, who claims the company lacks a strategy,” notes Adrian Day, who asserts, "We don’t agree.”

In his Global Analyst, he says, “In our view, the bank’s strategy – which emphasizes both China and the rest of Asia – is clear.” Here, he explains why the global bank is a core holding in his portfolio.

“HSBC has a long history of conservatism. As for corporate governance, HSBC, in my view, is one of the most ethical businesses around. It does things differently, but that doesn’t make it wrong.

“Most senior appointments are made from within the company, and though some criticize this, in my view it ensures that the company’s conservative and somewhat frugal culture remains intact.

“Further, HSBC has always been extremely conservative in its accounts—many say overly so -- and its disclosures to the market full and complete. Indeed, one could criticize the bank’s disclosures for often creating too bleak a view (as with its sub-prime write offs), but no-one could accuse the bank of sugar-coating problems.

“As for the shares being undervalued, well, yes they are, and that’s why we continue to recommend the bank as a core holding, and recommend buying on price weakness.

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“But we have never thought that a public company should devote its primary efforts to its stock price, but rather concentrate on running a solid business; if the company is solid, the share price will follow.

“Besides, HSBC has an enviable long-term record of shareholder returns. Its size, geographic and asset spread, and rock-solid balance sheet provide downside protection. It has proven itself to be one of the most nimble companies of its size in any industry.

“Following its write-offs in the U.S. mortgage business at the beginning of the year, U.S. profits fell, and sentiment turned negative on the bank, as the share price slid.

“But then the group reported its first-half results -- the group has traditionally eschewed quarterly reporting and a short-term focus -- which saw a spectacular jump in profits of 25%, despite the declines in the U.S.

“Earnings were higher everywhere else, with Asian profits up by one-third, year on year, and profits from China exceeding $1 billion. The bank maintains a strong emphasis on China --  after all, that’s where the bank began over a century ago.

“No question, there have been some missteps in recent years. The hiring of flashy outsiders to build an investment banking arm was one, I would say. And of course the bank’s problems in the sub-prime area are well known.

“”Meanwhile, sub-prime is only a small part of the bank’s overall U.S. mortgage business, itself a small part of the U.S. finance business, in turn a small part of the group’s worldwide activities.

“While reining in U.S. mortgage activity, the bank has expanded in other areas. In China, where it has the most branches (45) of any foreign bank, it is expanding into rural China (the first foreign bank so to do); and is now offering local yuan services.

“It has announced plans to expand, organically, in Japan, opening retail branches for wealth management. In Korea, it acquired a controlling stake in a large local bank (though the transaction still needs government approval).

“In other emerging countries, HSBC has acquired banks in El Salvador and Panama; is expanding its mortgage services in Latin America, particularly Mexico and Brazil (where the growth opportunities in are enormous as the middle class expands).

“The bank sees life insurance in emerging countries as an enormous growth opportunity in coming years. It has boosted services in China; made an investment in a Vietnamese insurer; and entered Taiwan, again through a joint venture.

“HSBC, a true worldwide bank, is a core holding for us, and still good value, trading at 11 times earnings (earnings that have move than doubled in four years), and yielding 4.7%. We’re happy holders and ready buyers on any price weakness.”

Editor's note: Adrian Day will be a featured speaker at the upcoming New Orleans Investment Conference scheduled for October 21-25 . For more information, visit their website.