HSBC (LSE: HSBA) and Lloyds Banking Group (LSE: LLOY) have two very different banking philosophies. HSBC, which calls itself “the world’s local bank”, is globally diversified, allowing it to spread risks across different markets and tap into faster growing economies. On the other hand, Lloyds relies on creating local economies of scale, which gives it a cost advantage in just one key market.
Both are viable bank business models, but which bank is currently the better buy?
Growth
Emerging markets may be a long-term growth opportunity, but right now it’s best to stay out. HSBC’s first quarter earnings fell 14% from the same period last year, as bad loans almost doubled and loan growth appeared to have ground to a halt. With earnings unlikely to cover dividends this year, questions are being raised over the sustainability of HSBC’s dividend.
In contrast to HSBC, Lloyds is seeing continued improvement in credit quality, with loan impairments down 6% in the first quarter. Lloyds’ underlying first quarter earnings, which exclude TSB, were mostly unchanged on last year, leaving forward looking estimates broadly intact. Forecasts point towards to an 11% increase in underlying earnings for Lloyds this year, compared to a 5% fall for HSBC.
Value
Despite robust earnings growth predicted for Lloyds, valuations for the bank are attractive. The bank may seem to trade at a pricey premium to tangible book value of 18%, but low forward looking earnings multiples make the bank seem very inexpensive.
| Lloyds | HSBC | |
| P/TBV | 1.18 | 0.77 |
| Forward P/E (2016E) | 8.6 | 10.5 |
| Return on tangible equity (2016E) | 13.8% | 7.5% |
Lloyds is expensive on a price-to-book ratio but cheap on a forward P/E basis, because the bank benefits from a much higher return on equity. The bank’s domestic focus and sizeable market share gives it a cost advantage over its peers, which means Lloyds can generate more profit for every pound of equity the bank carries.
By contrast, HSBC is cheap on a price-to-book ratio, but relatively more expensive on its forward P/E ratio. HSBC has a lower return on equity because as a globally systemic bank, it has to set aside more capital and faces higher regulatory and compliance costs.
Dividends
With a dividend yield of 7.8%, HSBC may be paying the bigger dividend, but Lloyds has the more attractive dividend profile. The domestically focused bank only yields 3.4% based on last year’s payout. But its dividend yield is set to soar in the coming years, as the bank lifts its payout ratio from currently around a quarter of underlying net income, to more than 50% in the longer term.
City analysts expect Lloyds’ dividend yield to rise to 6.7% this year, and 7.8% in the following year. This means that although the bank starts off with a lower yield, it would take less than two years for its yield to catch up with HSBC.
On the other hand, HSBC may struggle to maintain its dividend at current levels. Earnings per share this year are expected to fall short of its dividend and the bank has yet to reach its regulatory capital threshold for 2019. Already, dividend futures for the stock are pricing a 23% cut in its dividend for 2017.
On growth, value and dividends, Lloyds seems to be the better buy to me.
