Stockwatch: Buy or sell Metro Bank shares?

by Edmond Jackson from interactive investor |

Amid an institutional investor stand-off at this controversial company, our analyst reveals what he'd do.

Should you follow Norway's sovereign wealth fund – the world's largest with over $1 trillion equivalent assets – which has disclosed a 3.1% stake in mid-cap challenger bank Metro Bank (LSE:MTRO) after its share price slide?

Or should you take more notice of Odey Asset Management which continues to raise its short position to 4.21% - borrowing and selling another 0.38% of the issued share on 20 May – to represent a bet of over £50 million on Metro's market price continuing to fall?

Metro Bank floated in March 2016 at 2,000p per share and doubled over two years, but a hefty premium over net assets and questions over the American founder-chairman's lifestyle attracted short sellers – with Odey an early protagonist.  

Metro became the most-shorted on the London market, with 10.9% of its equity out on loan – a situation that has lately exacerbated due to speculation over a capital-raising.

Hedge funds attract criticism for "driving down share prices", seemingly on informed rumour ahead of placings or rights issues, or you could say they identify risk astutely.  

In the short term, at least, this can lead to a technical situation that "corrects" back up, as short-sellers buy back, although in the longer run fundamentals will still prevail.

Bank of England endorses capital position

Metro has raised £375 million at 500p to address an embarrassing revelation last January when its shares dropped 40%.

That was in response to an admission that hundreds of millions of pounds of commercial property loans, also to commercial buy-to-let operators, should have been classified among "risk-weighted assets".

Amid social media speculation that started to cause a run on Metro's reserves, the Bank of England has now gone so far as to declare Metro "continues to have adequate capital and liquidity to serve its current customer base."

Last Friday 17 May, the stock jumped to over 600p and continued to rally after Norges Bank declared its 3.1% stake on 21 May, reaching 885p on 23 May before plunging nearly 10% that afternoon (with the Wall Street sell-off), currently 773p.  Total stock out on loan has reduced to 10.4%.

It's hard to say if Norges opted to come into the placing afresh at 500p or increased a stake that was taken below the 3% threshold for disclosure.  

The fund has been in the news lately for raising their UK investments "whatever the outcome of Brexit".

Meanwhile, Odey has sat pretty through the demise of Debenhams, with a colossal 7.87% short there.

Analysts remain broadly cautious

They acknowledge scope for a 10%-plus short position to provide technical support as it closes, although with a fundamentals' perspective most are perturbed how their per share targets need revising down after the placing delivered 77% dilution.  

Shorters are also likely of the view that this won't be the last equity capital raise if tough competition and very low interest rates persist for UK banks.

Barclays targets 537p fair value after reducing its targeted net asset value (NAV) by 25%, while its "earnings" estimates remain the same at 30% below profits consensus (which is a remarkable mixing up of profit and earnings in the text).  

Upside exists, however, if Metro achieves loan sales and gains a credit rating, deferring the need for further equity.

Morgan Stanley is more bullish with an 830p target, anticipating some pricing support given a large short base "though we remain cautious on the longer-term outlook".

Panmure Gordon is the most negative with a 'sell' stance targeting 445p, although if the same analyst is involved I recall the same being said on Barclays (LSE:BARC) post the 2008 crisis which in fact recovered strongly.  

Its chief concern, after a weak trading update last January, is the extent of dilution from the placing coupled with reducing its forecasts for deposit and loan growth out to 2021:

"Although Metro Bank trades on a price to tangible book value of 0.6x we expect low returns over the next two years."

Net tangible assets around 700p per share

By my calculation, and if Metro's end-2018 balance sheet is realistic today, net assets were £1.4 billion, and deducting £197 million intangibles derives a net tangible asset value of 700p per share inclusive of the placing, taking total shares issued to 172.4 million.

Make of that what you will as a valuation benchmark, as net assets are relevant in the sense of what they can earn.  

Mind earnings per share (EPS) projections currently cited in tables - Company REFS shows a 67.9p consensus in respect of 2019 and 92.9p for 2020, albeit dated 13 April i.e. pre-77% dilution.

So, assuming profit expectations are realistic, then EPS would be nearer 30p in respect of 2020, and is why Barclays refers to an "uncompelling valuation".

Stocks do trade on high price/earnings (PE) ratios when it's reasonable to expect earnings recovery, but if 30p is a more realistic benchmark then, at 860p this last Thursday, the forward multiple approached 29 times.

The drop to 775p implies nearer 26 times.  Bulls are relying on Metro's management talking of 2019 being "a transitional year" in support of future growth.

Some £70-75 million of cost savings have been identified via branch efficiency initiatives and back-office savings, and a further £40-45 million capital expenditure savings.

Metro Bank - financial summary           Consensus estimates
year ended 31 Dec 2014 2015 2016 2017 2018 2019 2020
               
IFRS3 pre-tax profit (£m) -48.9 -56.8 -17.2 18.7 39.2    
Normalised pre-tax profit (£m) -48.9 -46.6 -11.3 24.6 45.1 97.9 144
IFRS3 earnings/share (p) -51.2 -61.3 -22.0 -22.0      
Normalised earnings/share (p) -51.2 -48.6 -14.3 13.2 -5.5 67.9 92.9
Earnings per share growth (%)             36.9
Price/earnings multiple (x)         -124 10.0 7.3
               
Source: Company REFS              

Overall good feedback on customer service

A Competition and Markets Authority survey has cited Metro as "the best bank for overall quality of service for personal current account customers and second for business current account banking".

It's also won the top award of £120 million from an RBS fund for "alternative remedies" to accelerate business services.

If you search around there are complaints too, but any business will see an element of dissatisfied customers take to the internet, and, overall, on Trustpilot the rating is 4 stars out of 1,067 reviews.

The first quarter of 2019 saw the customer account growth rate rise 10% to 1.7 million, with year-on-year personal current account growth of 24% and business current account growth of 23%.  

Year-on-year total deposit growth was 19% to £15.1 billion, which included a 3.6% reduction as a result of some customers withdrawing deposits after January's trading update.  However, this stabilised in March and returned to net growth in April.

What to make of it all

Recovery bulls have reason to be cheerful, but it remains to be seen if they can climb a wall of worry over the challenges for UK banks generally.  

I'd be increasingly wary of political/economic risk around a hard Brexit this autumn as the Tories change their leader - albeit achieving nothing if the EU won't budge from its withdrawal agreement. General election risk grows too.

If sentiment does turn adverse for the UK economy, financial shares will bear the brunt. The likes of Norges Bank can afford to take a very long view; their 3% stake in Metro is miniscule in portfolio context.

Not to criticise recent speculative buyers at around 600p, but until Metro Bank shows more consistency of fundamentals to counter dilution, and with due regard to precarious UK politics, I'd await a more favourable risk profile.  For now, with the share price testing 800p: Avoid.
 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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