Removed from Asia Pacific Conviction Buy List HSBC Holdings:Cut EPS/TP post UK referendum;off CL but remain Buy

What happened

We cut our 12-month RIM-based target price by 14% to HK$57 (HK$66prior), implying 0.84X 2016E P/B (0.97X prior). Our target price cut reflectsour lower EPS estimates and a higher COE following UK’s decision toleave the EU. As a result, we remove HSBC from our Conviction List.

However, we remain Buy-rated given trough valuations and ROE leverageto US$ rate hikes. Our new target price offers 22% potential upside and8.5% dividend yield. Since we added HSBC to our Conviction List on Sep22, 2015, it has fallen 22%, vs. MSCI Hong Kong Index’s -4% on Brexit andglobal macro concerns.

Current view

EPS cuts: We lower 2016/17/18 EPS by 3%/8%/9% as we reflect: (1) lowerrevenues on slower balance sheet growth, (2) delayed US$ rate rises andthe translation impact of the recent GBP move, (3) higher credit costs onEurope’s weaker credit quality. Europe makes up two-thirds of theearnings cut, with the rest attributed to Asia and US from US$ rate hikes.

Higher COE: We increase our beta assumption from 1.0X to 1.1X to reflectearnings, balance sheet, and operational uncertainty. This leads to anincrease in our COE assumption from 9.0% to 9.6%.

Valuation: HSBC trades at record low valuations of 0.68X 2016E P/B vs.

our underlying ROE estimate of around 7% this year.

We continue to believe HSBC has ample capital to withstand a highdividend payout this year (>100%) and can hold its DPS at the current level(vs. a 2% increase yoy that we expected previously). Also, managementdoes not target a dividend payout range, instead aiming for a progressivedividend policy based on medium-term earnings and its ability to supportit with capital on the balance sheet. HSBC’s ROE is positively geared toUS$ rate hikes and to the cost management efforts ongoing in the bank.

Key risks: Unfavorable regulation, worse than expected macro, margins,credit quality and progress on cost reduction.