HSBC: Brazil Unit Sale Provides Relief For The Stockholders

| About: HSBC Holdings (HSBC)

Summary

Brazil's watchdog approved Banco Bradesco’s acquisition of the local unit of HSBC.

The deal is expected to result in a circa USD1.7bn loss or ~16% of HSBC FY16E earnings.

However, completion of the sale of Brazil should add circa 65 bps to the group's CET1.

We expect a progressive dividend for 2016.

On 8 June, the Brazilian Administrative Council for Economic Defence approved Banco Bradesco's (NYSE:BBD) acquisition of the local unit of HSBC (NYSE:HSBC), adding a restriction that the buyer refrain from additional purchases for 30 months. Bradesco and HSBC plan to complete the transaction early in July.

Although the sale is a part of HSBC's strategy and was expected by the market, there were speculations that the sale would require deeper antitrust review. According to the Reuters sources, the Brazilian Administrative Council for Economic Defence (CADE) has been reviewing Bradesco's purchase since February due to the disputes among its directors. Moreover, Citigroup's (NYSE:C) sale of its Brazilian unit mignt face tougher scrutiny from Brazil's watchdog as the local banking industry is already highly concentrated.

The deal is expected to result in a circa USD1.7bn loss (~16% of HSBC FY16E earnings), so why is it positive for the dividend?

A circa USD1.7bn accounting loss is expected on completion of the Brazil sale, depressing HSBC's earnings in 2016. Having said that, the sale should decrease the group's risk weighted assets (RWA) by around USD37bn and increase HSBC's common equity tier 1 ratio by circa 65bps. Given that the headline dividend payout ratio for 2016/2017 will likely exceed 100% due to: a) revenues pressure; b) asset quality issues; c) litigation charges; and d) BoCom (OTCPK:BCMXY) earnings recognition, the group's capital position is crucial for the dividends. With further RWA cuts, we see HSBC's capital position as adequate and within its target 12-13% CET1 range by mid-2016, supporting a progressive dividend.

One important thing to note is a significant scrip component , which would dilute those who take cash dividends and, hence, cushion a negative impact on the capital.

We expect a dividend of USD0.52 for 2016

We do agree that the headline payout ratio >100% for 2016/2017 suggests a concern around dividend sustainability. However, we believe the company's management will remain committed to a dividend progression, thanks to strong capital adequacy ratios. We expect a dividend of USD0.52 for 2016 (i.e. USD0.01 higher than 2015).

Valuation

Click to enlarge

Source: Bloomberg, Renaissance Research

Click to enlarge

Source: Bloomberg, Renaissance Research

Bottom line

We would not recommend buying HSBC as there is no shortage of dividend stocks in the global banking space. ING (NYSE:ING), Lloyds (NYSE:LYG) and Credit Agricole (OTCPK:CRARY) are offering 6-7% yields and these stocks are a much more sustainable source of dividend income than HSBC. Having said that, many of HSBC's shareholders are there for the dividend, and we think the company's management acknowledges that the dividend is a cornerstone of HSBC investment story. Hence, we believe the management will remain committed to a dividend progression, thanks to strong capital adequacy ratios.

Disclosure: I am/we are long ING, LYG, CRARY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.