Does $2.5bn share buyback make HSBC Holdings plc a buy?
Shares of HSBC Holdings (LSE: HSBA) rose by nearly 4% to 500p when markets opened this morning, after the UK and Hong Kong-based bank said it would spend $2.5bn on a share buyback plan.
The bank's decision to return cash to shareholders isn't the result of bumper profits. HSBC's adjusted pre-tax profits fell by 14% to $10,795m during the first half of 2016. Return on average shareholders' equity fell from 10.6% to 7.4%.
The $2.5bn used for the share buyback will come from the sale of the bank's Brazilian business. HSBC's stance appears to be that with banking returns so low, it makes more sense to return cash to shareholders than invest it in low-yielding assets.
In a presentation to analysts this morning, HSBC said that further share buybacks may follow, subject to regulatory approval.
Is the dividend safe?
The sustainability of HSBC's dividend depends heavily on the strength of the bank's balance sheet.
Today's results contained good news in this area. HSBC's Common Equity Tier 1 ratio (CET1) rose from 11.9% to 12.1% during the first half. The sale of the bank's Brazilian operations is expected to increase this to 12.8% during the current quarter.
This increased level of surplus capital should help to secure HSBC's dividend, which provides a forecast yield of 7.5% at the current 500p share price.
On the other hand, such a high yield is often a warning that a cut is likely. Forecast 2016 earnings of $0.59 per share leave little room to cover the expected $0.49 per share payout.
In this morning's statement, HSBC chairman Douglas Flint tried to reassure investors that the dividend would remain safe, saying the bank is planning on the basis of "sustaining the annual dividend ... at its current level for the foreseeable future".
This doesn't guarantee the dividend will remain safe but is a strong indicator, in my view. I suspect the payout will be protected for the next couple of years at least.
A shift of strategy?
Today's half-year results suggest to me that HSBC is changing its strategy slightly. While still focusing on growth opportunities in Asia and the UK, the bank seems to be moving the focus away from outright growth.
It has "suspended" its return on equity target of 10%, which was always unlikely to be met. Share buybacks will help to bolster earnings per share and reduce the cost of the dividend in the face of falling profits.
I think HSBC is saying that there's only so much it can do to compensate for ultra-low interest rates. Rather than attempting the impossible, it will focus on improving the quality of its assets, maintaining its dividend and returning surplus capital to shareholders.
My HSBC holding is on hold
As a long-term income investor in HSBC, I'm quite happy with this. The current situation won't last forever. At some point, market conditions for banks will improve and profits will rise. I believe HSBC's large scale and focus on Asia should leave it in a strong position to profit when this happens.
However, the near-term outlook is uncertain and the stock's discount-to-book value is shrinking. I think the risks and rewards are evenly balanced at the moment. I rate HSBC as a hold after today's results.
Roland Head owns shares of HSBC Holdings. 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.