It’s been a dreadful six months for HBOS but there are signs it’s weathered the worst of the financial storm. Its shares now look cheap.
As expected, Thursday’s results from HBOS (LSE: HBOS) made very grim reading. Profits have more than halved and the interim dividend was not only slashed by almost two-thirds, it will be paid in shares rather than cold, hard cash.
Of course, the shares leapt on the news. In the perverse manner of the stock market there was relief that the figures weren’t even worse.
The half year in figures
Let’s look at some of the key numbers. Underlying profits were down 14% to £2.55bn. But a write down of almost £1.1bn in various financial instruments meant that profits after tax fell by 56% to £950m. The pace of these write downs has slowed significantly with ‘only’ an additional £67m being recorded since HBOS’s last trading update which covered the period up to the end of May.
A dividend of 6.1p will be paid in shares, with the exact number being determined by the share price over the first three trading days in October. That compares with a dividend of 16.6p paid at the half-way stage last year. Going forward, HBOS intends to pay out 40% of its underlying profits as dividends and re-iterated that it expects to pay the final dividend for the year in cash, although that won’t be paid until next May.
Net interest margin, the difference between the interest paid by borrowers and paid out to savers, registered a slight fall to 1.55%. HBOS expects this performance measure to increase over the next year or so.
Of most interest to many commentators is the proportion of HBOS’s loans that may not be repaid. Overall, this measure rose from 2.03% at the end of 2007 to 2.35% at the end of June. Within this the worst performances were from specialist mortgages (buy-to-let and in particular self-certified) and corporate lending.
Specialist mortgages rose from 2.59% to 3.27%, but the total level of arrears on all mortgages is the same as it was a couple of years ago when conditions were much calmer. Corporate arrears rose from 1.39% to 1.82%, which is perhaps not surprising given that 40% of HBOS’s business loans are to the property and construction sectors.
There were encouraging signs elsewhere though with falls in arrears on overdrafts and personal loans and just a small increase in credit cards.
House prices and the economy
As the country’s biggest mortgage lender, HBOS’s views on the housing market are always of interest, even if you violently disagree with them. It’s expecting a total decline of 15% to 20% over the whole of 2008 and 2009, which seems more pessimistic than its previous view of an up to 9% decline for this year.
It also expects the base rate to remain more or less unchanged for the remainder of the year and the mortgage funding markets, which have been key in driving the bank’s growth up until recently, to be shut for at least the next twelve months. In the presentation accompanying these results, HBOS was keen to stress the importance of maintaining its capital ratios and said it may dispose of assets if required, provided it can get a reasonable price.
Valuation
Whether HBOS shares now offer good value depends on your view of the economy. At 285p per share the business is valued at £15bn. While the results for the whole of 2008 will be bad, it’s those for 2009 and beyond which will be more relevant for the medium-term direction of the share price.
Profits after tax for 2007 came to £4bn so one measure you could use is to consider how much of these profits will be sustainable going forward. If you believe there will be a 25% reduction due to the lower availability of mortgage funding this implies profits of £3bn. This translates into a price earnings ratio of 5 times and a dividend yield of just over 8%. This is obviously cheap.
HBOS seems even more optimistic than this though. It expects long-term growth from its insurance and investment division to pick up the slack from lower lending profits. If the bank is right, and that’s a fairly chunky if, then its shares are ridiculously cheap at these levels. HBOS is the cheapest of the big five UK banks at the moment and probably the one most vulnerable to a takeover. Both these factors bode well for the shares too.
Economic bears will argue the last few weeks have just been the eye of the financial storm and downward progress will resume shortly. It’s impossible to tell who’s right but it would require a sizable economic downturn to make HBOS shares look expensive at their current level.
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