If China’s Growth Falters, HSBC Holdings plc & BHP Billiton plc Could Fall By 30%!

All eyes are on China this year as the country continues to restructure its economy away from manufacturing towards consumption.

Unfortunately, at the same time China’s economy is suffering a hangover from the debt binge it has been on since the financial crisis. The economy is also plagued by overcapacity, yet another side effect of the debt binge.

And how well the Chinese authorities manage the country’s economic slowdown is vital for the prospects of HSBC (LSE: HSBA) and BHP Billiton (LSE: BLT).

Depending on China for growth

Last year, HSBC decided to stake its future growth on China to counteract slower growth in the US and the Eurozone. If China’s growth starts to stumble, then HSBC’s going to have a hard time conjuring up similar growth elsewhere. 

HSBC’s grand plan is to refocus its operations on China, specifically the Pearl River Delta, which includes the mega city Shenzhen and Hong Kong. As part of this restructuring, the bank is slashing 50,000 jobs from its global headcount but increasing the number of workers it employs within China. At the same time, HSBC is looking to cut $290bn of risk-weighted assets from its global balance sheet, excluding China. Of these, management is seeking to redeploy $150bn of assets into Asian markets.

The problem is that HSBC is already struggling to redeploy these assets. China’s economic growth is slowing and as a result, the number of high-quality opportunities available to the bank to redistribute these assets is shrinking. 

So, there’s now a risk that HSBC could be cutting assets from its global operations without being able to redeploy them within China. Ultimately, this means the bank’s income will now come under pressure as the amount of assets earning a return for the company is set to fall.

Oversupply

BHP has also staked its future growth on China. As the world’s largest consumer of raw materials, commodity prices are highly sensitive to China’s economic fundamentals. A further slowdown in growth will only exacerbate commodity market oversupply, which is bad news for BHP.

Indeed, the world’s largest miner is already struggling to cut capital spending fast enough and reduce expansion plans to cope with the current downturn in commodity prices. 

BHP Billiton’s chief executive Andrew Mackenzie told CNBC last week that the slower growth in China had forced BHP to adopt a new dividend policy and capital allocation framework to manage volatility. Mackenzie also warned that iron ore supply continues to grow at a faster rate than demand and there’s a chance iron ore prices could suddenly lurch lower after recent gains.

Earnings decline

A rough analysis shows that HSBC generated pre-tax profits of $18.9bn last year on a total asset base of $2.4trn, a return on assets of around 0.8%. The bank’s return on assets has been relatively stable for the past five years. Assuming the bank can’t redeploy its $290bn of cut assets, and there are no other negative surprises, pre-tax profits could fall by around 10% to $17bn. After-tax earnings per share could fall by 30%.

And as for BHP, according to City analysts, if iron ore prices do fall further BHP’s pre-tax profit could fall by as much as 30%.