Published by Bob Ciura on May 27th, 2017
There are few industries in which foreign stocks offer significantly higher dividend yields than U.S. stocks.
Another is the financial sector. Many international banks offer 5%+ dividend yields, while the U.S. banking giants like JP Morgan Chase (JPM) and Bank of America (BAC) yield 2.3% and 1.3%, respectively.
For instance, Banco Bilbao Vizcaya Argentaria, S.A. (BBVA) is based in Spain and offers a hefty 5% yield.
Similarly, HSBC Holdings (HSBC) has a hefty 5.9% dividend yield.
This article will discuss HSBC’s business model and why it could be an attractive stock for income investors.
HSBC is a global financial giant. It was created all the way back in 1865, to finance trade between Europe and Asia. Today, it serves more than 37 million customers, in 70 countries and territories around the world.
The company operates four main businesses:
- Commercial Banking
- Global Banking and Markets
- Global Private Banking
- Retail Banking and Wealth Management
The Commercial Banking unit helps provide a range of financing solutions such as working capital, term loans, acquisition finance, and project finance to small, mid-sized, and large businesses. HSBC had $282 billion in commercial banking loans outstanding at the end of 2016.
The Global Banking and Markets division provides advisory, research and analysis, sales and trading, and transaction banking services.
The Global Private Banking business focuses on private financial solutions including banking, investment, and wealth management services to high-net-worth individuals such as business owners, entrepreneurs, and senior executives.
Lastly, the Retail Banking and Wealth Management segment offers a range of personal finance services such as personal banking, mortgages, loans, credit cards, savings and investments and insurance.
HSBC is headquartered in London, but the company has a diversified geographical footprint. It conducts a significant amount of business in Europe, but also has a major presence in Asia.
For example, in Global Banking and Markets, Europe and Asia account for 37% and 38% of annual revenue, respectively. In Global Private Banking, 38% of client assets are based in Asia, with 30% based in Europe.
2016 was a difficult year for the company.
Source: 2016 Annual Report, page 4
Revenue and profit came in well below 2014 and 2015 levels.
Earnings-per-share sunk from $0.65 in 2015 to $0.07 last year, as HSBC underwent a difficult restructuring.
However, now that the restructuring process is complete, the company is hoping it will see a return to growth in 2017.
Among the many factors that weighed on HSBC’s earnings last year were a $3.2 billion goodwill impairment in the Global Private banking business in Europe. In addition, earnings were reduced by $1.8 billion due to changes in credit spreads on the company’s own debt.
And, HSBC sold its operations in Brazil.
That said, on an adjusted basis, revenue and net profit before tax fell by just 2% and 1%, respectively, in 2016. This indicates the continuing operations of the company are still performing well.
Plus, many of the restructuring actions taken last year were done to reduce HSBC’s risk and cut costs, which will help the company return to growth.
For example, its cost-cutting initiatives has now reached an annual savings run rate of $3.7 billion. Going forward, the company expects to deliver annual cost savings of $6 billion by the end of 2017.
Furthermore, the decision to exit Brazil will help reduce the company’s risk profile, given the tumultuous conditions of the nation’s economy.
This is already helping to improve the company’s fundamentals. HSBC reported an 18% decline in profit before tax for the 2017 first quarter.
That said, excluding non-recurring items, adjusted revenue and profit before tax increased 2% and 12%, respectively, from the same quarter last year.
Source: Q1 2017 Earnings Presentation, page 6
The company saw growth across its 3 largest business segments.
The other good news is, the various restructuring items that dragged down HSBC’s earnings in 2016 had no impact on capital. As a result, the company is positioned well moving forward.
HSBC ended 2016 with a strong Common Equity Tier 1 ratio of 13.6%, up 170 basis points from 11.9% in the previous year. The CET1 ratio expanded further in the first quarter, to 14.3%.
Source: Q1 2017 Earnings Presentation, page 12
The restructuring also freed up a significant amount of cash, which the company is returning to shareholders. HSBC completed a $2.5 billion share buyback in 2016, and utilized another $1 billion for share repurchases in the first quarter.
Not only that, the stock pays a hefty dividend as well.
As an international company, HSBC trades on the NYSE through American Depositary Shares. Each ADS represents five ordinary shares of the company.
HSBC takes a somewhat unique approach to its dividend payments. Rather than pay a steady regular dividend each quarter, the company makes three regular quarterly dividends, then ends the year with a variable fourth-quarter dividend.
The benefit of this policy is that investors know what they are getting for the first three quarters, with the potential for a higher fourth-quarter payout if the company had an especially good year.
In 2016, HSCB distributed $0.10 per ordinary share for the first three quarters, and paid out $0.21 per ordinary share for the fourth quarter. The total dividends paid last year were $0.51 per ordinary share, or $2.55 per ADS.
Based on 2016 dividend payments, HSBC has a 5.9% dividend yield.
On May 4, HSBC declared an ordinary dividend of $0.10 per share for the first interim dividend of 2017, unchanged with the same quarterly payout last year.
Investors can elect to receive the dividend as new ADSs or in cash. Importantly, the dividend appears to be sustainable, given the company’s current financial condition.
HSBC has a well-managed balance sheet. Its senior debt is rated ‘A’ by Standard & Poor’s, ‘A1’ by Moody’s, and ‘AA-‘ by Fitch. These are solidly investment-grade credit ratings for HSBC.
The company did not cover its dividend with earnings-per-share in 2016, but if earnings recover at least to 2015 levels, the dividend will be covered once again.
High-yield dividend stocks can be riskier than stocks with lower yields. It is understandable for investors to view a 6% yielding bank stock with a certain amount of skepticism.
If another global financial crisis strikes, HSBC’s high dividend would likely be in danger. And, even if the global economy stays out of recession, the high dividend yield is still reliant on the company’s successful restructuring.
That said, the early signs are promising that HSBC’s turnaround is on the right track. And, HSBC gives investors exposure to the emerging markets in Asia, which could result in higher growth than the U.S. financial sector.
This makes HSBC a worthwhile stock for further consideration by investors looking for high dividend yields in the financial sector.