🏦 Why Investors Should Pay Attention to Bank Stocks
Fresh off a stellar set of results from NatWest last week, Lloyds, Barclays, and Standard Chartered saw their share prices soar. Here's why investors should pay attention to bank stocks again.
Hello there, I'm John Choong. Every week, I dig into the financial world's nitty-gritty with three in-depth segments. Here, I spill the beans on the latest macroeconomic data, news, and even offer a share tip or two. Join me as I dissect this week’s drama.
🗞️ This Week’s Highlights
✂️ On the Hunt for tax cuts: Net borrowing ex. banks missed estimates of £18.9bn, but the £17.26bn figure is still the largest surplus since records began in 1993. But whether this gives enough room for tax cuts remains the question.
🏇🏻 Lloyds gallops upwards: Shares of Britain’s largest bank jumped 5.3% after it reported results that were in line with estimates. Nonetheless, provisions regarding the FCA’s motor finance probe could cloud its future earnings.
🦅 Blue Eagle set for take off: Like its peers, Barclays also saw a massive jump in its share price this week. The stock rose by double digits, and even the most conservative estimates point towards a strong long-term investment case.
📊 Markets This Week
📈 FTSE 100: 7,710 (→0.00%)
🇬🇧 FTSE 250: 19,192 (→0.00%)
🧾 5-Year Yield: 3.932% (↓1.60%)
💵 GBP/USD: $1.27/GBP (↑0.59%)
🎟️ Barclays: 164p (↑11.65%)
✂️ On the Hunt for tax cuts
With the spring budget now just over a week away, everyone’s eager to find out whether Jeremy Hunt will make some bold moves come March 6. Rishi Sunak’s cabinet have been teasing the prospects of tax cuts, but how much, is the question everyone’s asking. Unfortunately, the latest borrowing figures paint quite a mixed picture and there’s no clear answer — but that doesn’t stop me from giving my take!
Taking the latest figures into consideration, many economists are estimating about a c.£10bn headroom for tax cuts, although this could be lower if the Office for Budget Responsibility (OBR) revise their economic forecasts.
That being said, one should always remember that Hunt isn’t the OBR — he’s a politician, who’s been ‘elected’, or at least vicariously through resignations and arguably poor choices. Nevertheless, it doesn’t change the fact that the OBR is a body that isn’t elected. If Hunt decides to do whatever he wants to, he technically can, although such a move didn’t work out the last time somebody else tried this.
But why shouldn’t he? After all, he’s got nothing to lose. The Conservative government are set for a landslide loss and the UK economy is already in a technical recession. Assuming he plays the card of enacting actual conservative policies, then tax cuts should be one of, if not the first thing on his agenda, regardless of whether the OBR gives the green light or not.
Hope as we may though, one shouldn’t forget Hunt’s character. Whilst I’m no political analyst, it’s safe to say that the Chancellor doesn’t exuberate Boris Johnson/Donald Trump vibes. In fact, he’s quite the opposite. Hunt has drawn much criticism from his own party for being technocratic, and relying too heavily on external bodies to make decisions for him, rather than doing what he deems to be ‘right’ for the country.
It’s on that basis, that I err on the side that Hunt will most likely play it safe, as he always does. Meaningful tax cuts could help lift GDP by as much as c.0.25% in FY25, according to the latest OBR estimates, so if the Conservatives are as serious as they say they are about pulling the comeback of the century, Hunt may be incentivised to prove himself as a capable Chancellor despite his lack of financial prowess.
Either way, if Hunt and his fellow MPs decide to borrow more than the supposed £10bn headroom they have, they can — they’ll just have to come up with a fool-proof plan to not send financial markets into turmoil vis à vis October 2022. Hence, they’ll have to show how that headroom for tax cuts can be extended to c.£20bn.
One such way to do this is to prove that government costs is likely to come down in the immediate future. With inflation forecast to dip below 2% come April, many of the government’s inflation-linked bonds should warrant lower financing over the year. As a result, this should theoretically free up more headroom for tax cuts as long as the government doesn’t spend that money elsewhere.
🏇🏻 Lloyds gallops upwards
In last week’s newsletter, yours truly found a way to help you beautiful readers make a quick buck with my Lloyds (LON:LLOY) share tip. Those who opted to follow suit with my recommendation would’ve seen your money gone up by a decent 5.3% after the Black Horse bank reported results that were in line with what markets were expecting, along with a decent outlook in the medium term.
For those who missed it, Lloyds reported a 4.6% increase in net interest income (the difference between interest the bank earns and pays) to £13.77bn from £13.17bn. The increase was due to higher interest rates, which helped to boost net interest margin (NIM) to 3.11% from 2.94%. However, the latter half of the year saw margins drop as financial markets began pricing in rate cuts, thereby pushing ‘real’ interest rates down.
Still, improved offerings from its other businesses such as auto loans, credit cards, and debt financing resulted in other incomes growing by 10%. This helped to push Lloyds’ underlying revenue up by 2.6%. Meanwhile, a combination of cost efficiencies and lower impairments from the Telegraph group settling its massive debt, saw provisions come in at a relieving £308m, down 80% from last year.
This resulted in pre-tax profits of £7.50bn which were 57% higher on last year, with basic earnings per share of 7.6p, which was 39% higher, boosted by the £2bn share buyback programme that ran until August.
Having said that, profits would’ve come in much loftier had it not been for the £450m the board allocated for remediation. This was to address the current probe by the FCA, who are looking into the potential mis-selling of auto loans through brokers. The probe stems from industry practices where brokers received commissions that incentivised higher interest rates, potentially harming customers.
Estimates of a potential fine ranging from absolutely nothing to £3.0bn could impact profits and returns moving forward. But for now, there’s some relief that management has only projected £450m of provisions for the issue. Of course, things could quickly turn sour, but given that dividends increased by 15% and another £2bn buyback was issued, there’s an element of confidence that this may be it.
“There remains significant uncertainty as to the extent of any misconduct and customer loss, if any, the nature of any remediation action, if required, and its timing. Hence the impact could materially differ from the provision, both higher or lower.”
*It’s worth noting that the current estimates are based on one financial ombudsman judgment with series of county court cases, most of which have actually been decided in favour of Lloyds, hence the confidence.
Regardless, the medium term looks promising for the firm. 2024 is expected to witness a sharp drop in profits due to the drop-off in margins. Despite that, investors can expect to see growth in the 20%’s in 2025 and 2026. But how can this happen if interest rates are projected to fall with margins expected to decline as a result? Well, let me introduce you to the beauty of the structural hedge.
*Structural hedges serve as insurance against interest rate declines. In this case, Lloyds buys long-term bonds with high yields to ‘lock in’ higher rates for when interest rates are lower, therefore securing higher income for the future.
To put it simply, most of the low-yielding bonds Lloyds purchased years ago are only expected to expire in the latter half of 2024. As such, higher structural hedge income will only come through when the board renews those bonds at much higher rates (think from 1% to 4%). This is why the group’s structural hedge income will only serve as a stronger tailwind from H2’24 onwards.
Additionally, things are looking up for the FTSE 100 stalwart on other fronts. Deposit outflows are beginning to stabilise and are estimated to reverse course in 2024, while rate cuts also anticipated to encourage higher loan growth. More importantly, asset quality remains impeccable, as late-stage loans are alleviating alongside a resilient and improving economic outlook.
Therefore, in spite of the potential fine from the FCA (we’ve accounted for c.£1.70bn of fines through to 2026 as our base case), we still reiterate our Buy rating for Lloyds, albeit at a downwardly revised price target of 55p from 61p. This includes a relatively conservative margin and income outlook, so investors can be more assured that there’s more room for upside potential than downside risks.
🦅 This Week’s Share Tip: Barclays
Apart from Lloyds, another bank was flying. Earlier this week, I posted on my LinkedIn that the bottom could very well be in for Barclays (LON:BARC), given how oversold the stock was/still is. Thus, I couldn’t be more delighted to see the Blue Eagle bank soar this week. Its results, particularly in Q4, were disappointing to say the least, but it was the guidance management gave that saved it from further obliteration:
💷 Group Total Income: £25.34bn (↑1.7%)
🇬🇧 UK Net Interest Margin (NIM): 3.13% (↑c.27bps)
❌ Group Impairments: £1.88bn (↑54.2%)
💰 Group Profit Before Tax (PBT): £6.56bn (↓6.5%)
🪙 Diluted Earnings per Share (EPS): 26.9p (↓9.7%)
Those who’ve been invested or have monitored Barclays since the arrival of CEO C. S. Venkatakrishnan will know that his tenure has been nothing short of poor. Since taking over, the Barclays share price has stooped by 14.9%.
Sure, some of the decline can be attributed to market-wide factors such as the decline in IPO activity as interest rates rose and the lack of M&A. But then came the infamous structured notes blunder, as well as Venkatakrishnan’s tendency to overpromise and underdeliver on earnings — the latest Q4 numbers being another example.
Be that as it may, the markets seem to have bought his vision of cost-cutting, managing efficiencies, and reinvigorating Barclays’ investment banking business which has plateaued over the past two years. All of these are expected to see greater returns on tangible equity (RoTE), from 10% in 2024 to 12% in 2026, all while returning AT LEAST £10bn to shareholders in that period.
Even so, we’re sceptical. We’re a Barclays shareholder ourselves, so we’ve got every incentive to pump up the stock, but we also feel the need to be honest and realistic in our assessment. Truthfully, we’re doubtful that such ambitious targets can be achieved given Barclays’ track record and current macroeconomic environment, but we’re not going to say that it’s unlikely either, hence why our recommendation.
There are green shoots, after all. Like Lloyds, deposit churns are slowing, loan growth should return, and investment banking activity is kicking off again. According to Dealogic, Q1 activity so far has seen the highest amount of deal value since Q1’22, and is on track to surpass last quarter’s figures. Furthermore, the conglomerate’s card business continues to exhibit high growth potential.
So, even applying a c.15% discount to current consensus estimates (assuming that’s how low earnings will go to if Venkatakrishnan underperforms again), the compound annual growth rate through to 2026 for Barclays isn’t too dissimilar from Lloyds’. And when taking into consideration that Barclays trades on a lower multiple, the upside based on earnings potential is a risk taking, in our opinion.
As of today, based on our projections, Barclays shares trade at a price-to-earnings growth and dividend yield (PEGY) ratio of 0.50. As a consequence and in combination with historical valuation multiples, we’re of the opinion that upside potential in relation to downside risks remains favourable. For this very reason, we’re issuing a Buy rating with a price target of 210p, implying a c.28% upside from current levels.
Why follow John’s share tips?
Rated as the #1 Tipster by Stockomendation, John Choong boasts a remarkable 66% average hit rate and a 12.4% average annual return, outperforming the long-term stock market average. In addition to that, his insights and comments are often cited in renowned financial publications such as the Financial Times, Bloomberg, Yahoo Finance, and many more.
🔎 What to Watch Next Week
🏠 Mortgage Approvals: Given the gradual rise in mortgage rates since the latter half of January, estimates for mortgage approvals aren’t expected to tick up meaningfully. Current consensus see a print of c.51.1k from December’s 50.5k, but don’t be overly surprised if the print comes in lower and stagnates there in February too.
📑 S&P Manufacturing PMI: Although not usually as important as services due to its relatively minimal impact on UK GDP, those worried about the potential impact of the Red Sea attacks on goods prices may want to read the fine print on input and output prices. Any sharp spikes may end up getting passed onto consumers. Anyway, consensus estimates see a print of 47.1, up 0.1 from January.
✈️ IAG FY23 Earnings: It was a solid week for IAG as it looks to turn its falling share price around, given that it’s lagging its peers in 2024. Heathrow’s recent numbers and credit card spending data point towards another strong report which has already been priced in, but the devil will be in the guidance. Look out for those overpriced fuel hedges as well.
🏘️ Taylor Wimpey FY23 Earnings: With Taylor Wimpey’s Q4 update in January already teasing what those top and bottom line numbers could be, much of the focus will be on three things — reservation rates since the start of the year, more detailed guidance (eg. build cost inflation), and outlets.