Stockwatch: a bank share at an inflection point for recovery
4th January 2022 11:16
by Edmond Jackson from interactive investor
Bank stocks are building blocks for a 2022 portfolio if bullish predictions for the British economy are fair, explains our companies analyst.
How seriously should we take growth forecasts of 5% or better for our economy this year? Goldman Sachs is positive and also expects the UK to outpace all other G7 nations for a second year. HSBC’s economists agree.
The EY Item Club is even more bullish at around 7%, arguing that households’ strong financial reserves accumulated during lockdowns, plus a revival in business investments, will more than offset constraints.
Pantheon Macroeconomics plumps for just over 4%, but says the rebound should still be material given the 2020 recession was so deep.
I am wary because soaring energy bills and rises in council tax and national insurance – on top of mid-single-digit inflation generally – could conspire to temper demand. According to the extent of interest rate rises, there will also be a ripple effect on mortgage rates.
But I would respect that bank shares are generally early stage beneficiaries of economic recovery, just as they sell off on expectations of recession.
Lloyds and Metro, according to your risk appetite
Lloyds Banking Group (LSE:LLOY) has the most UK exposure of mainstream listed banks. Over 2021, its share price rose 37% to 48p, and this year the prospect that a first series of interest rate rises in over a decade will follow December’s rate rise, should benefit operations. Lloyds rates the easier “buy” and sense of a core holding.
My mind is exercised however by turnaround prospects at Metro Bank (LSE:MTRO), which is wholly exposed to the UK, and at 96p trades at an 81% discount to tangible net asset value, or TNAV, (as of last June) versus 14% for Lloyds.
The disparity reflects Metro’s losses since 2019 versus Lloyds’ profitable if bumpy underlying numbers (see tables), although, in fairness, Metro generated £552 million free cash flow in 2020 from underlying operations not disposals.
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Launched in 2010, Metro floated in 2016 and saw its shares nearly double from £22. But in 2019 they collapsed after regulators found high-risk commercial property and buy-to-let loans had been misclassified. A new CEO has been in place since early 2020 and declared satisfactory progress against his strategic plan at last September’s interims; also, a third-quarter update last October.
I do have concerns that Metro is hardly a unique “challenger bank” nowadays, versus competition from the fully listed Wise (LSE:WISE) (also founded in 2010), Starling (2014) and Monzo (2015). Mainstream banks have also met the digital challenge.
But such is the extent of festering negative sentiment in this stock it likely explains why a New York investment management firm has just recently accumulated an 8% stake.
Admittedly, that is worth only £13 million given Metro is capitalised at just £166 million versus £34 billion for Lloyds. Yet it looks an enterprising speculation on the CEO improving the return on Metro’s assets, in which scenario its stock should at least double.
Progress at Metro’s interim results but third quarter mixed
For the first half of 2021, underlying revenue rose 17% to £179 million – or by 47% when adjusting for the disposal of a mortgage business. Metro’s underlying pre-tax loss reduced from £183 million to £110 million in context of the end-June group balance sheet showing £5.1 billion cash.
A reported loss of £139 million – if down on £241 million in the first half of 2020 – included one-off items such as intangible impairment, the CEO characterised as “reflecting where we are in our turnaround plan, as well as the impact of lockdowns.”
He cited higher-yielding mortgage products, lower cost of deposits and entering personal lending as marketing examples on the road to profitable growth.
What initially jarred about October’s update was an 18% fall in loans versus 30 September 2020, although the figure was flat on 30 June 2021. It was explained by lower residential mortgages and commercial lending – not exactly affirming economic recovery, at least in this three-month period. Growth in consumer unsecured loans and specialist mortgages offset the drop during the three months, but the overall message did not exactly convey “recovery”.
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Deposits rose 5% to £16.4 billion like-for-like, albeit 1% easier versus 30 June. The deposit mix improved by way of current and instant-access accounts, while higher-cost fixed term deposits reduced.
The CEO declared: “We have seen improvements in our lending mix from our expanded product offering. We are seeing signs of a gradual return to normality…We remain focused on executing our plans and returning the bank to sustainable profitable growth.”
Approach by Carlyle Group private equity
A takeover approach was flushed out by a news report early last November and did involve Metro engaging with Carlyle for two weeks before negotiations were terminated.
It is tricky to decipher if a low-ball offer was the chief reason, as Metro did engage time rather than immediately rebuff. But say an offer of 200p a share was mooted; acceptance would have made the board look foolish – or at very least, having no faith in the CEO it appointed – versus net tangible assets of £894 million or 519p a share. If his statements at the last two reporting occasions are credible, then Metro and its shares are broadly at an inflection point for recovery.
Carlyle’s approach can be seen as a logical move at what could be the latter phase of the pandemic. Two weeks’ negotiation was insufficient for due diligence to get underway – i.e. uncover negatives.
Its walking away, plus the uninspiring third-quarter update, likely conspired for Metro shares to fall to 83p by 15 December.
Lloyds Banking Group - financial summary
Year ended 31 Dec
| 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | |
| Turnover (£ million) | 24,840 | 41,662 | 35,798 | 28,469 | 43,814 | 30,637 |
| Operating profit (£m) | 1,644 | 4,238 | 5,275 | 5,960 | 4,393 | 1,226 |
| Operating margin (%) | 6.6 | 10.2 | 14.7 | 20.9 | 10.0 | 4.0 |
| Net profit (£m) | 860 | 2,413 | 3,559 | 4,408 | 2,925 | 1,318 |
| Reported earnings/share (p) | 0.8 | 2.9 | 4.3 | 5.5 | 3.5 | 1.2 |
| Normalised earnings/share (p) | 2.1 | 3.6 | 4.9 | 6.4 | 3.9 | 1.2 |
| Operating cashflow/share (p) | 22.6 | 2.9 | -4.4 | -15.4 | 15.8 | 38.1 |
| Capital expenditure/share (p) | 4.7 | 5.2 | 5.1 | 4.9 | 4.8 | 4.1 |
| Free cashflow/share (p) | 17.9 | -2.3 | - 9.5 | -20.2 | 11.0 | 34.0 |
| Dividend/share (p) | 2.3 | 2.6 | 3.1 | 3.2 | 3.3 | 0.6 |
| Earnings cover (x) | 0.3 | 1.1 | 1.4 | 1.7 | 1.1 | 2.1 |
| Cash (£m) | 83,268 | 74,158 | 65,116 | 61,132 | 63,663 | 81,616 |
| Net debt (£m) | 30,990 | 33,678 | 29,791 | 49,925 | 47,603 | 21,653 |
| Net assets (£m) | 46,589 | 48,375 | 48,906 | 49,925 | 47,603 | 49,184 |
| Net assets per share (p) | 65.2 | 67.7 | 68.0 | 70.2 | 68.0 | 69.4 |
Source: historic company REFS and company accounts
Metro Bank - financial summary
Year ended 31 Dec
| 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | |
| Turnover (£ million) | 120 | 195 | 294 | 404 | 422 | 434 |
| Operating profit (£m) | -56.8 | -17.2 | 18.7 | 40.6 | -131 | -311 |
| Operating margin (%) | -47.3 | -8.8 | 6.4 | 10.0 | -31.0 | -71.8 |
| Net profit (£m) | -49.2 | -16.8 | 10.8 | 27.1 | -183 | -302 |
| Reported earnings/share (p) | -61.3 | -21.8 | 12.6 | 28.3 | -124 | -175 |
| Normalised earnings/share (p) | -53.0 | -17.2 | 13.9 | 31.6 | -89.6 | -122 |
| Operating cashflow/share (p) | 680 | 1,522 | 2,670 | 160 | -1,109 | 616 |
| Capital expenditure/share (p) | 99.1 | 186 | 198 | 235 | 135 | 63.8 |
| Free cashflow/share (p) | 581 | 1,336 | 2,471 | -75.1 | -1,244 | 552 |
| Cash (£m) | 282 | 500 | 2,212 | 2,472 | 2,989 | 2,993 |
| Net debt (£m) | 280 | 153 | -2,091 | -1,879 | -1,807 | -1,870 |
| Net assets (£m) | 407 | 805 | 1,097 | 1,403 | 1,583 | 1,289 |
| Net assets per share (p) | 507 | 1,001 | 1,240 | 1,440 | 918 | 748 |
Source: historic company REFS and company accounts
Stake-building by Spruce House Investment Management
US investor Spruce House bought determinedly into the latest fall, raising its stake from 3% over 4% on 19 November, then to over 5% a week later. Through December and in three purchases involving around 1% of the equity, it reached 8% on 23 December.
For context, in terms of taking your cue from other’s dealings, I last wrote on Metro in June 2020 with a “Hold” stance at 110p after the chairman and a non-executive director bought £76k and £40k of shares respectively at around 80p. I argued that a “sell” stance – such as that from broker Investec – assumed a worst-case UK economic scenario.
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Investec reckoned there was no point waiting until 2024 “for any kind of profit”. That is being verified to date, but I think Spruce’s action shows buying for recovery will happen before profits are in.
A modest 2.6% of Metro’s equity is sold short, 2% of which is operated by Odey Asset Management which raised its position by 0.1% of the equity on 21 December. They get some such trades right but others wrong.
Transformational change against all five pillars of a strategic plan
This was set out in 2020 and looks par for the course of a turnaround: Balance sheet optimisation via acquisitions and disposals, shifting towards higher returns; Revenue, with more products launched; Cost reductions by improving automation, IT, customer service and property; hence in parallel an Infrastructure objective; finally, Communications which included a smaller to medium-sized enterprises’ marketing campaign.
Metro has to be seen as a speculation, also a bet net on the UK economy making progress in 2022. Yet its extent of discount to NAV means that unless a steep recession resulted in bad debts, downside risk should be limited and timing could finally be opportune. Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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