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“Not pretty, but reasonably cheap” was basically the essence of my investment case when I opened on Asia-focused bank Standard Chartered (OTCPK:SCBFY)(OTCPK:SCBFF) with a Buy rating last year. More specifically, while this bank was/is structurally less profitable than certain peers, a then-valuation of 0.7x tangible book value did not require miracles in terms of profitability, offering investors re-rating potential if the bank could hit management’s double-digit return on tangible equity (“RoTE”) target.
The stock has been a disappointing performer since then, underperforming Asia-focused multinational peers like HSBC (HSBC) and DBS Group (OTCPK:DBSDY)(OTCPK:DBSDF) with a circa flat total return.
Data by YCharts
With tangible book value per share (“TBVPS”) rising in that time, Standard Chartered’s valuation multiple has slipped to a little over 0.6x, which looks too cheap notwithstanding its somewhat lackluster RoTE profile. With that pointing to double-digit annualized returns along with a margin of safety, I keep my Buy rating in place despite the disappointing performance so far.
Investment Case Recap
Standard Chartered is headquartered and has a primary share listing in London, but its business is focused on Asia and emerging markets (“EM”). Of the circa $17 billion it reported in income last year, around $12.5 billion was generated in Asia and $2.8 billion in Africa & the Middle East (“AME”). Corporate, commercial and institutional banking accounts for the majority of its income (~$11 billion last year), with a relatively smaller retail & small business arm (~$7 billion).
By business line, Transaction Banking accounted for around one-third of income last year. This is a broad product category but basically involves servicing the day-to-day needs of business customers, and includes working capital services (e.g. supply chain finance), payments (e.g. Transactional FX) and many other products/services that facilitate trade (e.g. providing letters of credit). For Standard Chartered, this is a source of both fee income as well as net interest income (“NII”) generated from client deposits.
While the above suggests that Standard Chartered is a good way to play rising Asian and EM growth, it has historically suffered from poor profitability, averaging a circa 6% RoTE between 2016 and 2023. A large contributor to this was risky lending practices and restructuring charges booked in the mid-2010s, which depressed RoTE to the low single-digit area.
Data Source: Standard Chartered Annual Reports
The initial Buy case was that Standard Chartered’s valuation largely reflected these past transgressions. While still structurally less profitable than the Asia-focused peers mentioned above, factors including higher interest rates and a lower cost of risk would nonetheless boost through-the-cycle profitability enough to drive a re-rate.
Recent Results Largely Supportive
Standard Chartered’s recent results largely support the above. In Q4, the bank reported underlying pre-tax profit of $1.05 billion, better than analysts expected but ultimately mapping to a RoTE of just 10%. For 2023 as a whole, Standard Chartered also reported RoTE of around 10%. Though this arguably meets its cost of equity, just about scraping a double-digit RoTE in a favorable macro environment (higher interest rates and very benign credit quality) could generously be described as average. In contrast, peers like HSBC (~15% RoTE) and DBS (~18%) were comfortably in the mid/high-teens area respectively last year.
NII accounted for around 55% of Standard Chartered’s total income last year. As expected, higher rates have been a benefit but this has now largely run its course. NII was $2.39 billion in Q4, up 6% year-on-year but essentially flat since Q2, with the bank grappling with headwinds in the form of weak loan demand and funding cost pressure. Similarly, Q4 net interest margin of 1.70% was 12bps higher than the equivalent period in 2022 but has also been fairly flat since Q2.
Source: Standard Chartered 2023 Annual Results Presentation
Credit quality remains strong and is supporting earnings. Last year, Standard Chartered booked $528 million in credit impairment expenses, equal to just 17bps relative to total loans and below management’s through-the-cycle guidance of 30-35bps. There is still little sign of deterioration in its loan book, with Stage 3 credit impaired loans flat year-on-year at 2.5% of gross loans.
More Of The Same Expected Going Forward
While interest rate cuts and normalizing credit quality represent potential headwinds to Standard Chartered’s earnings, it is important to note that other factors can act to offset this. Indeed, management guidance has 2024 NII at $10 billion at the low-end, implying growth even in the face of rate cuts later in the year.
Firstly, in terms of interest rates, Standard Chartered will enjoy medium-term support from structural hedge income. This is conceptually similar to investing in a portfolio of fixed-rate securities that generates spread income. As rates have risen, the bank has increased the size of its structural hedge to around $47 billion, while the yield earned increased to 3.1% last year from 2% in 2022. While volume growth is likely to slow, maturities can currently be laid on at higher yields. This will offer a degree of protection to NII in the event that interest rates fall later this year. Furthermore, rate cuts should help spur demand for credit. This is currently a weak spot for the bank, with underlying net loan balances down around 1% year-on-year in Q4 to $287 billion.
Source: Standard Chartered 2023 Annual Results Presentation
I would also point out that Standard Chartered has significant non-NII lines of income, a number of which are counter-cyclical in nature and have strong secular growth potential. For instance, Wealth Management income increased 10% in constant currency terms last year to $1.95 billion. As rates fall, clients will have greater incentive to shift cash over from deposits, boosting the bank’s fee income. As Standard Chartered is the third largest wealth manager in Asia, this also offers attractive longer-term growth potential.
Other business lines like Debt Capital Markets should offer a similar profile, with Standard Chartered among the largest bookrunners in areas like the Middle East & Africa. Deal volumes there appear to have started the year strongly according to investment banking league tables. As such, I expect both near-term NII and non-NII income growth to more than offset normalizing credit expenses, helping to sustain the bank’s earnings power around its current level.
Valuation Now Looks Compelling
At ~$17.90 in current trading, Standard Chartered’s ADSs have fallen around 4% since my opening article back in September. The primary-listed London shares have performed a little worse due to FX, currently trading for around £7 per share versus around £7.60 last time. As TBVPS has increased ~7% in that time to $13.92 per share ($27.84 per ADS), the stock’s multiple has fallen from ~0.7x TBVPS to a little over 0.6x. The market is basically forecasting a return to the single-digit RoTE the bank averaged over the past decade or so.
In contrast to the market’s view, management is guiding for RoTE of 12% by 2026, aided by the trends outlined in the previous section. Now, while I expect the bank’s earnings power to remain closer to its current level than management’s goal, a ~10% RoTE would still represent a big improvement on its recent past.
One reason for that is asset quality. Yes, credit impairment charges will trend higher from here, but this is to be expected and many banks are in the same boat in this regard. The important point is that current 30-35bps through-the-cycle guidance would represent a material improvement on levels seen back in the late-2010s (average ~75bps), reflecting the work the bank has done in reducing risk in its loan book.
Data Source: Standard Chartered Annual Reports
For instance, investment grade credit exposure now represents a much larger slice of total lending than in the past, accounting for over 70% of total corporate exposure last year versus just over 40% in the mid-2010s. Other issues that troubled the bank have also been addressed. For example, exposure to highly cyclical industries like oil & gas and metals & mining has been pared back, which is largely what got the bank into trouble before.
Data Source: Standard Chartered Annual Reports
Importantly, Standard Chartered doesn’t need to reach management’s profitability target in order to produce good returns for investors. On a roughly 9-10% RoTE and 0.6x TBVPS multiple, the stock would offer a circa mid-teens internal rate of return. For the same reason, capital returns potential looks reasonable here. Since the dividend payout ratio is low at around 20% of net income, this is mostly in the form of buybacks – highly value creative at the current share price.
Last year, Standard Chartered delivered $2 billion in stock buybacks, reducing the share count by around 8% on an end-of period basis. As it has increased the dividend by 50% to $0.27 per share ($0.54 per ADS), I expect annual buybacks to fall slightly going forward (to around $1.8 billion), though again mapping to a high single-digit rate of share count reduction. As such, Standard Chartered should be able to grow TBVPS at a ~10% annualized clip, leading to total shareholder returns in the low-teens area after including the ~3% yielding dividend. With this looking attractive and not requiring multiple expansion to work, I keep my Buy rating in place.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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