Turkey of the week: don’t catch this falling knife

By Tim Price Apr 20, 2008

Tim Price

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The parlous state of the credit markets and UK mortgages is well known. Sentiment toward the market and this stock won’t have been helped by last week’s report by broker Tradition Financial Services that UK property prices will decline for another three years and probably won’t rise above current levels until 2017.

HBoS (HBOS), cut to ‘UNDERPERFORM’ at Credit Suisse

Those forecasts come from derivatives linked to a HBoS index. HBoS itself said on 8 April that property prices in March fell by 2.5% – their largest monthly fall since 1992.

Few FTSE 100 stocks ever trigger a probe into possible stock manipulation by the Financial Services Authority, but this was HBoS’s somewhat ignominious fate last month following a 17% share price fall on the back of rumours that the mortgage and credit provider had sought emergency funding from the Bank of England.

Jonathan Pierce of Credit Suisse last week cut his price target for the stock from 890p to 565p, citing a weak domestic housing market and other capital concerns. Pierce said the downgrade reflected earnings cuts, a general reduction in the valuation of financial businesses, and the introduction of a 10% discount to reflect capital-related issues: “In an environment of a weakening housing market and mortgage market, and the many different ways that it affects HBoS, we do not see how the shares can sustain any significant recovery for now.”

Pierce is hardly alone. On Monday, US investment bank Lehman Brothers’ (itself the target of market rumours over exposure to subprime losses) lead analyst Robert Law issued a research note indicating that UK banks, including HBoS, and also RBS and Barclays, may be more vulnerable to the credit crunch than their European peers. “UK banking is at the start of the most significant credit deterioration since the early 1990s.” British banks are “over-leveraged” in credit funding and capital compared to their continental cousins, and “the reduction of this leverage over time will affect earnings, return on equity, and threaten dividend payments”. 

Much of this deterioration in outlook has already been priced in. But looking at the technical picture, there seems little obvious reason to catch this falling knife. Between June last year and mid-March, HBoS stock fell by 60%. Having bounced off the “FSA low”, the shares seem bereft of any obvious support. Other than taking a purely contrarian stance for contrarianism’s sake, there is little reason to try to pick the low.

The shares trade on a forward p/e ratio of five and offer an apparently attractive 9.6% net dividend yield, according to Bloomberg analytics, but that yield could be a trap. If HBoS is forced to trim its dividend, the figures are meaningless. Twenty-eight brokers cover HBoS. Eight analysts rate the stock a ‘Buy’, nine say ‘Sell’ and another 11 suggest ‘Hold’ (the polite City word for ‘Sell’). 

Recommendation: AVOID

Tim Price is Director of Investment at PFP Wealth Management. He also edits The Price Report investment newsletter.

Published in Tips & advice | More articles by Tim Price

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