Big upsides seen after UK bank sector results

Banking stocks remain off limits for many investors, but analysts are taking a different view after upgrading their estimates on the back of recent results.

UK lenders continue to attract favourable City comment after a big upgrade for NatWest (LSE:NWG) was today followed by a broker’s 87% upside estimate for Virgin Money (LSE:VMUK) shares.

Liberum’s view that the FTSE 250 company is “materially undervalued” was based on Virgin’s recent third-quarter trading update, which pointed to progress on its digital first strategy.

Analyst Shailesh Raikundlia said: “With interest rates continuing to rise and mortgage spreads easing, we believe there remains upside risk to our and consensus expectations.”

He increased forecasts for each of the next three years after Virgin’s trading update showed the net interest margin and credit quality continuing to surpass expectations, with costs remaining in check despite inflationary pressures.

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Virgin’s shares added a penny to 145.85p but this compares with Liberum’s new target price of 280p after its upgrade from 260p previously. The stock rallied from 124p in mid-July to 158p a month later, but has fallen back since then.

That’s been in keeping with the share price movements for blue-chip counterparts including Lloyds Banking Group (LSE:LLOY) and NatWest (LSE:NWG). The latter continues to be one of the top picks for many City analysts, including those at Jefferies after the US bank yesterday lifted its target price on NatWest to 424p from 359p. The shares were at 258.8p today. 

UBS banking analyst Jason Napier is also a fan on the basis that NatWest offers the highest gearing to interest rate rises and there’s also September’s planned capital distributions providing shareholders with a pay-out equivalent to 6% of market capitalisation.

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Napier has a 315p target price, with Lloyds and Barclays (LSE:BARC) at 65p and 250p respectively.

He added: “We continue to like the UK banks for rate gearing (with the Bank of England less likely to disappoint on the volume of hikes to come than, say, the ECB, for example), resilient credit quality and premium capital distributions.”

Standard Chartered (LSE:STAN) is Napier’s top international pick based on a target price of 850p, while HSBC (LSE:HSBA) is also in favour due to its 8% 2023 yield and strong dollar-linked gearing target. 

His note on Friday suggested that a 12% rally for the sector since mid-July was more likely to be due to a market-wide upturn in confidence rather than recent results changing the minds of investors on owning banks when heading into a recession.

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Napier’s review came after UK lenders delivered a 21% profits beat to consensus in the second quarter, driven by better income and lower-than-expected impairments. A stronger outlook for net interest income, with Lloyds and NatWest beating by around 5%-6%, drove some big increases to UBS’s 2022 and 2023 pre-provision profit estimates.

He believes that high collateral levels and an improved credit mixed mean conditions are more defensive than is assumed in valuations, despite the pressures of inflation, tighter monetary conditions and rising unemployment.

Napier added: “Up-to-date credit quality and spend data shows no deterioration yet, sharply different from sentiment readings.”