Banking stocks slumped this week following the announcement of weak results in the first three months of 2016 thanks to market turbulence and client risk aversion.
HSBC Holdings PLC (HSBA), the biggest bank by market value traded in London, revealed yesterday that its first-quarter profits had fallen by 14%, fuelling doubts among investors the bank’s ability to generate dividend growth.
Will HSBC be the Next Large Cap to Cut Dividends?
For many investors, the main question about HSBC is whether it will be able to maintain its progressive dividend policy. Therefore following a weak start of 2016 in banking shares it comes as no surprise that HSBC came third in the most searched for stocks list among Morningstar.co.uk readers last month.
Morningstar analyst Erin Davis admitted she remained sceptical about HSBC’s dividend growth in the near-term due to weak revenue growth. Being a large systemically important financial institution, the bank made little progress to maintain more capital in its latest quarter result, with dividends and growth consuming all of the capital it generated. The stock is rated as a four-star undervalued stock by Morningstar analysts.
“We think it needs to build a 1%-2% buffer on top of its 11.5% common equity Tier 1 ratio target, which means that dividend growth could be pressured if profit growth doesn't strengthen,” Davis said, “We think a dividend cut could be in the cards if conditions continue to deteriorate.”
Falling Chinese growth and commodities prices are major drivers to dampen HSBC’s growth and they could lead to a sharp increase in loan losses, as well as the vote on Britain’s membership of the European Union in June 23. Davis commented that a vote to exit would likely have negative secondary consequences, such as a slowdown in GDP growth and currency fluctuations, which would affect the bank's results.
UK Banks Pull Down FTSE
After the bank’s quarterly result, HSBC and Barclays (BARC) led declines among European banks today. While HSBC were down more than 1.6% to 438p at 2pm on Wednesday, shares of Barclays fell as much as 2%. Lloyds Banking Group PLC (LLOY) managed to hold its loss, losing 0.7% to 65p.
Amid uncertainty due to fears about China's economic slowdown, global growth and low oil prices, market volatility in January and February hit banks’ ability to generate revenue in markets and their businesses. Banks’ profits were also sapped by a negative interest rates being chased by central banks to try to prod more life into economies. Major banks shares posted losses year to date: HSBC has lost 10% year to date while Barclays has traded down 23.4% year to date. Lloyds has also fallen 8.5% year to date.
Barclays came fourth after HSBC as the most viewed stock among Morningstar readers, following its February’s announcement to cut more than 50% of its dividend for the next two years. Although concerns about Barclays' viability have eased, questions about write-downs and long-term profitability remain. Barclays is on track to meet incoming capital requirements but regulators are constantly threatening to further increase requirements, which would bite further into Barclays' profitability.
Barclays' future in investment banking is unclear despite the new CEO, the bank has yet to prove that it can find a product mix that will allow it to cut costs enough to produce attractive returns to shareholders. Until it does, shareholder returns will suffer, according to Davis. Barclays also faces a number of misconduct charges, all of which are likely to be costly to shareholders, Davis added.
Lloyds: Growth in Progress
While other banks are struggling, with noncore assets and government ownership now down to minimal levels, Lloyds is re-emerging as the bank it once was, a strong, conservative, and impressively profitable retail-focused institution, say Morningstar analysts. It is also the top most searched for stock among readers in the past month.
Analysts are comforted by Lloyds’ chief executive Antonio Horta-Osorio’s historically adept control of credit risk, but still wary about what this may mean for future loan losses. Davis expected the bank to deliver a dividend with a 5.8%-plus forward yield in 2016. The stock is a four-star undervalued stock rated by Morningstar analysts.
The Oil Conundrum
The fate of global oil companies remains uncertain as oil majors struggled to agree a deal on oil freeze. As a result BP PLC (BP.) has experienced a volatile start of the year with both good and bad news coming forth. However the stock managed to gain 6.1% year to date, and it came fifth on the top 10 most popular securities last month.
Morningstar analyst Stephen Simko commented that it is clear the company continues to prioritize protecting its dividend and would do whatever it takes to avoid reducing it. The stock is rated as a two-star overvalued stock by Morningstar analysts.
Investors are also closely watching another oil company Royal Dutch Shell PLC (RDSB) coming in second on the top 10 list. The company said today its earnings plummeted in the first quarter of the year and warned earnings will fall even further in the next quarter as all of its divisions will suffer from reduced production, while exceptional costs will rise thanks to the BG Group acquisition. However, the oil giant also said its full-year expenditure is likely to be considerably lower than previously guided. The stock lost 1.9% on Wednesday by 2pm but has gained 14.5% year to date.
Uncertainties in oil prices also trigger concerns over small cap mining stock 88 Energy Ltd (88E) and energy provider Flowgroup PLC (FLOW). 88 Energy lost 8.3% on Wednesday by 2pm while Flowgroup lost 1.2%.
Supermarket, Pharmaceutical and Telecom Stocks
Other popular stocks on the top 10 list are grocery giant Tesco (TSCO), pharmaceutical company GlaxoSmithKline PLC (GSK), and telecom company Vodafone Group PLC (VOD). Tesco lost 4.3% in day trading by 2pm on Wednesday, GlaxoSmithKline was down 1.7% and Vodafone lost 1.6%.
