Yesterday, in a move that stunned markets around the world, China devalued its currency. The move, designed to stimulate economic growth sparked fears that the countrys economy is in worse shape than official figures suggest bad news forHSBC(LSE: HSBA).
Indeed, two months ago HSBC unveileditsnewstrategy, which involves apivot to Asia and southern China. Simply put, the bank is planning to increase its exposure to China over the next few years.
But as China struggles, HSBC will find it difficult to achieve the sort of growth management needs to hit profit targets. Whats more, as Chinese economic growth slows, theres a chance the financial troubles could spill over into HSBCs most profitable market, Hong Kong.
Overweight China
HSBC has long been overweight China. The bank generatesa large chunk of its income in Hong Kong and has become reliant on this market to produce group growth.
In particular, for the first-half of 2015, HSBCs profit jumped 10%, thanks to aninvesting frenzy in Hong Kong among individual customers prompted by Chinas soaring markets earlier in the year. Unfortunately, sluggish growth in other markets, such as the UK, Europe and the US held back the banks growth.
Asia is HSBCs largest market. During the first-half, 69% of group pre-tax profit came from HSBCs Asian arm. However, only 36% of HSBCs assets are located in Asia. Nearly 50% of HSBCs assets are based in Europe, although Europe as a whole only generated 16% of group pre-tax profit during the first-half.
Low returns at HSBCs European division are a direct result of the regions high costs. HSBCs European operations reported a cost efficiency ratio of 78% during the first-half, and 111% at the end of 2014. In comparison, the groups Asian operations reported a cost efficiency ratio of 39% for the first-half and 47% for full-year 2014. Throughout 2014, HSBCs management was targeting a group cost efficiency ratio in the mid-fifties. Its clear that HSBCs European operations have been holding the group back.
Nevertheless, with such a high dependence onAsian economic growth, HSBC stands to take a huge hit if Chinas growth hits a wall. Many Asian economies feed off Chinas success, and any slow-down will reverberate across the region.
Lack of growth
If sales at HSBCs Asian division start to slow, the group will struggle to grow. HSBC is currently undergoing a broad restructuring, selling off non-core assets and businesses. These sales will reduce the banks global footprint and impact sales.
However, for the most part, the assets HSBC is selling are low-return assets. The money raised from selling the assets could achieve a better return by being invested elsewhere.
Still, as HSBC sells off international assets and refocuses on Asia, the bank is reducing its international diversification. Over the next fewyears, HSBC will become a more Asia-focused bank, and as a result, the banks growth will become highly correlated to Chinas economicsuccess.
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Rupert Hargreaves has no position in any shares mentioned. 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.