Diverging earnings outlook

Since the EU referendum of 23 June, analyst earnings forecast revisions for the two banks have diverged sharply. Expectations of Lloyds’ earnings have gone down by 6.0% for 2016 and 13.2% for 2017, while HSBC’s expected earnings for HSBC have improved by 3.5% and 0.6%, respectively, for those two years.

Because of Lloyds’ much greater exposure to the UK economy, the Brexit vote has hit the bank hard in two ways. First, slowing growth in the UK economy has hurt the bank’s outlooks for loan demand and credit quality. Second, the Bank of England’s August rate cut will likely reduce the bank’s net interest margins — the spread between what banks make on loans and pay for funding.

HSBC is affected in much the same way, but because of its global diversification, the bank is less exposed to headwinds from the UK market. Meanwhile, because of the falling value of the pound, the sterling value of its overseas earnings have hugely improved since the Brexit vote.

Also, following the disposal of its Brazilian unit and a dividend from its US business, HSBC is buying back some $2.5bn of its shares. This reduces the bank’s outstanding share count, which gives a boost to earnings per share.

Short-term phenomenon

However, the weak pound is only likely to be a short-term phenomenon. HSBC’s underlying fundamentals remain weak because of slowing economic growth in emerging markets and its high cost structure. Despite efforts to become more efficient, HSBC has a cost to income ratio of 63.2%, compared to Lloyds’ 47.8%.

Moreover, credit quality is deteriorating faster at HSBC than it is at Lloyds. For the first half of 2016, loan losses rose 64% at HSBC, compared to an increase of 37% at Lloyds for the same period. Lloyds also has a higher CET1 capital ratio – 13.0%, compared to 12.1% for HSBC.

What’s more, with earnings expectations cut back for Lloyds and valuations in the bank already heavily marked down, there is significant upside potential from Lloyds delivering better than expected results. This could come from many things, but will most likely be due to a more-resilient-than-expected UK economy.

Bottom line

It’s quite possible that HSBC will continue to outperform Lloyds for some time. After all, it’s clear that investors are shunning domestically-focused firms in favour of big “dollar-earners” — companies that earn most of their earnings overseas, and which are therefore benefiting from the pound’s weakness.

However, I expect Lloyds to outperform HSBC in the longer run due to its better underlying fundamentals. Valuations for the bank are also more attractive, with shares in Lloyds trading at 8.7 times this year’s expected underlying earnings, compared to HSBC’s multiple of 13.6.

The post Can HSBC continue to outperform Lloyds? appeared first on The Twelfth Magpie.

More reading

• Is there any value left in Lloyds shares now they’re over £1?
• Up 250%! Here’s why I bought HSBC shares over SpaceX stock
• Prediction: this UK growth stock will outperform Lloyds shares over the next 5 years
• Barclays, NatWest or Lloyds shares: which is the better pick for a UK retirement portfolio?
• How much might £19,999 in a Stocks & Shares ISA be worth by 2036?

Jack Tang has a position in Lloyds Banking Group. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

In the short run, one of the main effects of a weaker pound will be inflation. Imported goods will become increasingly expensive and higher costs for businesses are likely to be passed on to consumers. Clearly, UK consumers are concerned about what this will mean for the affordability of their goods and services. Inflation has already crept up to 1% since the referendum and is very likely to move higher.

However, the amount by which prices will rise could prove to be lower than anticipated. In other words, inflation may not move to an excessively high level. That’s due mainly to a continued deflationary cycle across the world economy. In the US, inflation is still relatively low and China’s GDP growth rate is set to slow in the coming years. Therefore, central banks are somewhat nervous about raising interest rates across the developed world for fear of encouraging deflation to take hold rather than being worried about inflation.

As such, UK interest rates may be kept low or moved even lower in the coming months. This has the potential to stimulate the UK economy since exporters will become increasingly competitive on price versus their foreign peers. Therefore, investing in UK companies that have operations abroad (which a large number of listed companies do) could prove to be a sound move over the medium term.

UK exposure

Such companies sometimes have very little exposure to the UK economy. This could help to protect investors from potential weakness in the UK economic performance in the short run. A number of FTSE 100 stocks may report in sterling but their operations are focused abroad. Therefore, they’re currently gaining from a positive currency translation, which is set to continue. This could be an opportunity for investors to buy them ahead of further weakness in the pound.

Of course, the pound is weaker because confidence in the UK economy has deteriorated in recent months. In other words, a weaker pound mirrors the outlook for the UK economy. In the short run, it could encounter difficulties such as higher unemployment and slower GDP growth as the Brexit effect takes hold. In turn, this may harm the financial performance of UK-focused retailers, banks and other companies that are reliant on the UK for most of their earnings.

However, this situation offers the chance for long-term investors to buy such companies while they trade at a discount. This wider margin of safety could equate to higher long-term gains and make Brexit and a weaker pound the best buying opportunity for a number of years.

The post Why a weak pound is great news for UK investors appeared first on The Twelfth Magpie.

More reading

• Back below 500p, is it time to consider BP shares again?
• Is there any value left in Lloyds shares now they’re over £1?
• How much would I need in a Stocks and Shares ISA to target £19,036 a year in second income?
• After huge new nuclear deals, are Rolls-Royce’s sub-£15 shares set to power higher?
• This 7.5% yielding passive income share is at a 13-year low! Time to consider buying?

A weak currency causes imports to become more expensive. This has started to become evident this week as the standoff between Tesco and Unilever has dominated news headlines. Unilever is attempting to raise prices by a rumoured 10% because it says that its costs are now higher. In response, Tesco isn’t restocking Unilever goods since it apparently doesn’t wish to pass on the price rise to customers for fear of becoming uncompetitive versus rivals. Nor does it wish to bear the higher cost itself, which would be to the detriment of its own financial performance.

To pass on costs or not to pass on costs?

The situation between Tesco and Unilever is one likely to be repeated in a range of industries. That’s because imports are inevitably now more expensive than prior to the EU referendum. The impact on inflation is down to whether the companies that experience higher costs choose to pass them on to consumers in the form of higher prices or whether they choose to keep prices as they are and absorb the costs themselves.

For most goods that have a positive price elasticity of demand, the burden of higher import costs could be shared between buyer and seller. This would hurt the financial performance of UK companies that rely on imports and it could also cause inflation to spike in the short term.

However, inflation may not reach sky-high levels. Certainly, an increase from the current level of 0.6% seems very likely, but other factors may keep it at historically normal levels. Among these are UK interest rates, which may have to rise in order to combat inflation. The scope for this to take place may be higher than many investors realise, since a weak sterling provides a boost to exporters. This could have a positive impact on UK economic growth and mean that an interest rate as low as 0.25% is no longer desired.

Furthermore, the world economy is still facing a period of deflation. This has lasted since the credit crunch and it’s a key reason why the Federal Reserve and Bank of England have maintained a dovish stance on monetary policy. A slowdown in China is expected to continue over the coming years and so the impact on inflation of a weaker pound may be offset by global deflationary forces. And with inflation in the UK being near-zero in recent months, it has a long way to go before it reaches a worryingly high level.

So, while the weak pound is likely to stay over the coming months, the level of inflation may not reach troublesome levels. Therefore, the fear it’s creating among investors could be a good opportunity to buy high quality UK-focused stocks at a discount to their intrinsic value.

The post Will a falling pound cause sky-high inflation? appeared first on The Twelfth Magpie.

More reading

• Back below 500p, is it time to consider BP shares again?
• Is there any value left in Lloyds shares now they’re over £1?
• How much would I need in a Stocks and Shares ISA to target £19,036 a year in second income?
• After huge new nuclear deals, are Rolls-Royce’s sub-£15 shares set to power higher?
• This 7.5% yielding passive income share is at a 13-year low! Time to consider buying?

Peter Stephens owns shares of Tesco and Unilever. The Motley Fool UK owns shares of and has recommended Unilever. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Well, that cash was never there for the NHS, economic growth forecasts by the Bank of England have been slashed, and unemployment is predicted to rise. And the pound has collapsed to its lowest level for 168 years!

Against a basket of other currencies, according to the Bank of England, sterling is actually at its all-time weakest since records began, plunging as low as $1.2117 on 11 October. And with UK interest rates possibly set to be cut even further and US rates rising, we might not be at the bottom yet.

Will it hurt?

But what difference, other than making our imported goodies more expensive, taking a big slice off our holiday spending money, and probably triggering inflation in the medium term, will it make to private investors?

Well, actually, it should make very little difference at all.

In fact, former Bank of England chief Mervyn King has even suggested that a low pound should make a welcome change for us. Speaking to Sky News, Lord King reminded us that before the vote some were claiming that if we chose Leave we might end up with “higher interest rates, lower house prices and a lower exchange rate” — but he added “that’s what we’ve been trying to achieve for the past three years.“

Our investments

Let’s consider a few companies we might want to buy shares in.

How about Royal Dutch Shell, the biggest in the FTSE 100? Shell is a truly global company and conducts very little of its business in the UK. The price of oil is quoted in dollars, Shell’s accounts are done in dollars and its UK dividends are converted from dollars… so that 188 cents per share. If repeated this year, you’ll get you more pennies.

Second placed HSBC Holdings is similar, with hardly any of its profits coming from the UK. China and the Asian region provides the lion’s share, and while a Chinese slowdown was our biggest fear that really wasn’t the place to be. But now, HSBC is safe from Brexit, it’s impervious to the value of sterling, and its earnings and dividends are going to be worth more in pounds.

The same is true as we go down the list. BP, GlaxoSmithKline, Vodafone, Diageo, Unilever… they’re all international companies whose business, earnings and dividends are almost totally independent of sterling.

Smaller sufferers

The companies that will suffer will be manufacturers who source their components and raw materials overseas, but sell the bulk of their products here in the UK. They’ll see profits fall if they don’t raise their prices — so factory output prices are worth monitoring over the next few months. But even then, prices from competing imports will be instantly more expensive already.

The big lesson from the unexpected Brexit vote and the resulting run on the pound is that if you stick to solid companies operating internationally and paying reliable dividends, your investments will just shrug it off… and they might even provide better rewards.

The post How will your investments fare as the pound plunges to a 168-year low? appeared first on The Twelfth Magpie.

More reading

• Back below 500p, is it time to consider BP shares again?
• Is there any value left in Lloyds shares now they’re over £1?
• How much would I need in a Stocks and Shares ISA to target £19,036 a year in second income?
• After huge new nuclear deals, are Rolls-Royce’s sub-£15 shares set to power higher?
• This 7.5% yielding passive income share is at a 13-year low! Time to consider buying?

Alan Oscroft has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline and Unilever. The Motley Fool UK has recommended BP, Diageo, HSBC Holdings, and Royal Dutch Shell. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Here are two FTSE 100 companies I expect to boost their dividends substantially in the coming months.

Improving earnings outlook

Going by the recent British American Tobacco (LSE: BATS) recent operating performance, I’m confident the tobacco giant will raise its dividend very soon. Revenue for the company grew by almost 8% year-on-year in constant currency terms during the first half of 2016, as core brands benefitted from higher sales volumes and good pricing. Adjusted diluted earnings per share were up by almost 11%, with further profit growth likely to be weighted towards the second half of the year because of short-term currency headwinds.

The company, which earns most of its revenues in emerging market currencies, had been hard hit by the slump in the Russian rouble, Brazilian real and South African rand. However, as these emerging market currencies have strengthened considerably against the pound following the Brexit vote, its full-year earnings are set to get a rather significant boost.

Following a series of healthy upward revisions in recent weeks, city analysts now expect the company’s earnings per share will grow 17% this year, to 244p. And on top of this, adjusted EPS is forecast to grow another 12% in the following year, to 274p.

That’s great news for income investors, because rapid earnings expansion is almost always the precursor to robust dividend growth. And while the pace of dividend growth has slowed in recent years (from 17.1% in 2010 to just 3.8% for the most recent interim dividend), British American Tobacco should once again be in a strong position to re-accelerate dividend growth thanks to its improving earnings outlook.

Scope for dividend growth

Meanwhile, publisher Relx (LSE: REL) is expected to post a 16% rise in adjusted EPS this year, with a further increase of 10% pencilled-in for 2017. Like British American Tobacco, Relx generates most of its revenues from outside of the UK, which allows it to benefit from improved sterling earnings translation of its foreign income.

But in addition to a weaker pound, Relx is set to benefit from the sector’s shift from print to digital. The company’s specialisation in scientific and medical publishing and its rich datasets give the company a unique competitive advantage as the market undergoes a structural shift. And already there are signs that it’s doing well in leveraging its strengths. Adjusted operating margins have improved from 27.6% in 2012 to 30.5% last year, thanks to the fixed costs of running digital infrastructure.

Quietly, Relx has also put together an impressive dividend growth story. Over the past three years, dividends have grown by an annual compound average growth rate of 8.9%. With an attractive earnings outlook and a dividend coverage ratio of two times, Relx is in a strong position to reward shareholders with increasing dividend payouts in the future. 

The post Why I think these 2 stocks will boost their dividends appeared first on The Twelfth Magpie.

More reading

• Double a state pension thanks to dividend shares? Here’s how it could be done
• How much second income am I aiming for with £20,000 in this superb FTSE 100 dividend star?
• The top 3 FTSE shares for beginner investors to consider buying in 2026
• Could a second income become more important than a pay rise?
• In the event of a stock market crash, is this one of the best stocks to consider buying?

Jack Tang has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

The pound is currently trading at £1 = $1.275. This is its lowest level in over a decade and there are two main reasons for it. The first is uncertainty regarding the outlook for the UK economy. With Brexit looming, the Bank of England has slashed its growth forecasts. It now expects the UK economy to grow only slightly in 2017 and unemployment to rise by 0.5% over the medium term.

Uncertainty could increase significantly when the UK government invokes Article 50 of the Lisbon Treaty next year, with a two-year negotiation period to follow. Then, once that is completed, the UK will finally go it alone as an independent state which is no longer in the EU. This could prove to be the most uncertain period of the lot and the pound could come under further pressure.

The second reason for the pound’s weakness is interest rates. Since the EU referendum the Bank of England has halved the base rate to 0.25%. This fall in the interest rate has the effect of weakening a country’s currency. The Bank of England has also indicated that further falls will be put in place should the economic circumstances make it necessary.

In contrast, the US Federal Reserve is set to increase interest rates over the next year, as the US economy has a much more certain outlook than the UK economy. This will have the effect of strengthening dollar, which means that it will strengthen further versus the pound.

A weaker pound is both a bad and a good thing.

It’s bad because it could cause higher inflation, as the cost of imports rises. Shopping bills may rise and eat into disposable incomes, thereby causing consumer spending to come under pressure. However, a weaker pound also means that companies that report their earnings in sterling but which operate mainly abroad gain from a positive currency impact. In other words, exporters become more competitive and their sales recorded in foreign currencies gain a boost when translated into sterling.

The FTSE 100 is full of international stocks, many of which have next to no exposure to the UK economy. In this sense the FTSE 100 is detached from the UK economy. As such, the outlook for the UK economy has less impact on the FTSE 100’s performance than on the pound, since many of the FTSE 100’s constituents are more directly impacted by the performance of the US and Chinese economies than they are by the UK economy.

This combination of a positive currency translation from a weaker pound and a lack of exposure to the UK economy means that the FTSE 100 has risen in recent months. With the outlook for the UK economy being uncertain, it would be of little surprise for there to be a continued fall in the pound and a further rise in the FTSE 100 in the future.

The post Why is the pound falling when the Footsie is rising? appeared first on The Twelfth Magpie.

More reading

• Back below 500p, is it time to consider BP shares again?
• Is there any value left in Lloyds shares now they’re over £1?
• How much would I need in a Stocks and Shares ISA to target £19,036 a year in second income?
• After huge new nuclear deals, are Rolls-Royce’s sub-£15 shares set to power higher?
• This 7.5% yielding passive income share is at a 13-year low! Time to consider buying?