The banking sector was under pressure last night, but HSBC held its ground after a broker suggested the market might be underestimating the group's earnings potential.
Bank of America-Merrill Lynch said that while forecasts had risen steadily since the second quarter, HSBC was likely to witness "a further sustained period of earnings upgrades" as the market gained confidence in the global economic outlook and played "catch up" with improvements in credit costs and revenues. Indeed, if the market moves towards Merrill's forecasts over the next six to 12 months, consensus estimates for 2010 could rise by more than a quarter.
"Furthermore, as we have only factored in a moderate improvement in margins in the second half of 2010 and 2011 ... we believe the risk to our earnings estimates is to the upside, particularly across HSBC's emerging market operations in Asia and Latin America," the broker explained, adding that, besides the earnings story, the HSBC investment case was also supported by its defensive qualities and the prospective dividend yield of 3 to 4 per cent, which should lure income-focused investors.
"Looking briefly at the situation in Dubai, while the last 12 months have shown you can 'never say never' in financial markets, we believe that market's concerns about the possible impact to HSBC are overblown," Merrill said, revising its stance on the stock to "buy" from "neutral". HSBC's shares closed broadly unchanged at 707p, up 0.7p.
In the wider sector, Barclays lost 5.5p to close at 292.35p, while Lloyds fell 3.45p to 55.15p and saw its target reduced to 60p at Standard & Poor's Equity Research. Royal Bank of Scotland retreated by 1.545p to 33.180p and Standard Chartered was 36p behind at 1484p. Overall, the FTSE 100 index fell 55.05 points to 5,190.68. The mid-cap FTSE 250 index closed 113.1 points lower at 8,918.44 as worries about the situation in Dubai continued to weigh on sentiment, although they were less pronounced than last week.
Looking ahead, David Jones, the chief strategist at the City spread betting firm IG Index, said trading was likely to remain subdued in advance of Friday's US unemployment report, because traders might "choose to keep their power dry" until the data was out of the way. "Bearing this in mind, and with the volatility experienced on Thursday and Friday, it could be a quiet few days ahead," he added.
Parts of the mining sector were firm as the US dollar renewed its decline. The Eurasian Natural Resources Corporation, which close almost 2 per cent, or 16p, higher at 861.5p, was supported by Credit Suisse, which switched its stance on the stock from "neutral" to "outperform". The broker also boosted Anglo American, which was 15p higher at 2603p after Credit Suisse reiterated its positive view.
"We expect more positive developments at Anglo over the next few months as the management will attempt to pull out all possible stops to avoid another bid from Xstrata in around five months time," the broker said. It maintained an "outperform" stance on the stock and at the close Xstrata was 3p behind at 1069p.
Elsewhere, United Utilities was unsettled after Goldman Sachs highlighted the possibility of a dividend cut. The broker said that in light of Ofwat's final price determination last night, the cut in the rate of return was likely to be hard to bear for water companies. It added that United and Severn Trent might need to cut their dividends by 20 per cent. The former may also need to raise capital "to avoid a significant breach of Ofwat's gearing targets", Goldman added. The comment contributed to United's 3.3p decline to 476.7p. Severn Trent, however, fared better and rose by 10p to 1050p.
Yell, the directories group, rose by 1.75p to 38.76p after announcing the completion of its refinancing exercise. The stock was also supported by Deutsche Bank, which said that in light of the capital restructuring, the balance sheet was "no longer an overhang" on the share price. "We anticipate a material recovery in earnings over the next three years, driven solely by reducing interest costs," the broker said, lifting sentiment around Yell.
Further afield, Nomura supported the mood around the soft drinks maker Britvic, which gained 11.1p to 392.6p after the broker upped its target price for the stock from 410p to 500p. "We believe the current valuation does not reflect the strong top-line outlook for [growth in the UK] as well as upward margin momentum," Nomura said, repeating its "buy" recommendation on the shares.
UBS drove sentiment around DSG International, the electricals retailer which rose by 0.16p to 36.66p after the broker upped its target on the stock to 45p from 37p. Taking its cue from the recently published half-year results, UBS said it was raising its forecast for pre-tax profits for 2010 to £100m from £54m, up 85 per cent. "There are a number of structural challenges for [the] UK electricals [market] but we believe that DSG is going back to basics through improved retailing methods and more efficient operations," the broker said, sticking to its "buy" stance on the shares.