Stockwatch: Could Metro Bank shares really double?

by Edmond Jackson from interactive investor |

A chance to significantly narrow a massive discount to net assets has piqued our analyst’s interest.

Similarly, as Metro Bank (LSE:MTRO) became way over-priced – up at 4,040p in March 2018 – it is interesting to consider the odds that this stock has now over-shot after a 95% fall.

Since last September, Metro Bank shares have bumped along in a 167-264p range and currently sit at 207p, so will be an interesting test of so-called market efficiency. Is it fairly priced for its risks, or can reasonable progress in operations under a new CEO see it narrow the existing 70% discount to net tangible asset value (NTAV) of around 700p a share?

Founded in 2010 as both a retail and commercial bank, Metro expanded rapidly to 75 branches and, to its credit, has won customer acclaim for service that includes friendlier opening hours. The bank is nowadays rated number one by the Competition and Markets Authority no less, for overall quality of service for personal current account customers, and second for business account customers. That’s a genuine intangible value to work with, additional to 700p bare bones.

It took until 2017 for Metro to start showing profitability (see table). However, second-half 2018 stock market turbulence saw its highly rated stock drop to around 1,700p. Then, last January, it dropped a clanger, classifying some £900 million commercial property loans and loans to buy-to-let operators incorrectly for risk.  

Source: TradingView Past performance is not a guide to future performance

Tougher trading had also compromised prior earnings guidance, albeit still up on 2017.  Understandably, the property market has ground to a near-halt, significantly due to Brexit, although mortgage margins were also hit by competition. Bad publicity over the bank’s woes led to a 4% fall in deposits during the first quarter of 2019: hardly a run though, and which reversed to inflows later in the year.

The stock was open to ridicule by its flamboyant US founder-chairman: Metro having paid over £25 million to his wife’s architectural business, also his £120,000 allowance for private jet transport. By March 2019 it was the second most-shorted stock on the London market.

Easing of macro risks normally helps bank stocks

I examined Metro Bank shares at around 800p last May, concluding it was best avoided until it provided more consistent fundamentals, and with due regard to precarious UK politics. So I’m jumping the gun somewhat on that first criterion although I think Metro merits attention - at least to watch more closely, than dismiss, given scope for fresh hands at the top to de-risk the bank hence its stock achieve some convergence on net asset value (NAV).

Crucially for bank stocks the domestic political situation is now clearer and, despite 2020 starting with an eruption of the US/Iran conflict, both sides are de-escalating it. Bank stocks are liable to take macro shocks on the chin, in anticipation of recession doing real damage to their results. But unless Iran’s proxies proceed to cause no end of trouble and Boris makes a pig’s breakfast of EU trade talks, the macro context looks relatively better, helped also by perceived progress in US/China trade talks.

It certainly improves the outlook for Metro now that it has addressed its capital strength issues and a new CEO builds on operational success and is, crucially, making cost savings, including a variety of options such as asset sales and selective branch closures.

Metro’s chairman and CEO have both been replaced with interim appointments, the new CEO being a fresh pair of hands having joined Metro last September as chief transformation officer. His prior experience had been eight years at a community bank based in Bermuda as chief risk officer, then chief operating officer, and before that at Royal Bank of Scotland and Northern Rock.

Cynics might say those latter qualifications make it appropriate that he’s turned up at Metro, although a search continues for a new CEO, and I note that a hedge fund once shorting stock has now gone long, significantly in the belief the new man is a strong pair of hands.

Metro Bank - financial summary            
year ended 31 Dec 2013 2014 2015 2016 2017 2018
             
Turnover (£ million) 31.5 75.4 120 195 294 404
Operating profit (£m) -55.4 -48.9 -56.8 -17.2 18.7 40.6
Operating margin (%) -176 -64.8 -47.3 -8.8 10.0 10
Net profit (£m) -46.4 -41.1 -49.2 -16.8 10.8 27.1
IFRS3 earnings/share (p) -57.9 -51.2 -61.3 -21.8 12.6 28.3
Normalised earnings/share (p) -57.9 -51.2 53.0 -17.2 13.9 31.6
Operating cashflow/share (p) 310 1009 680 1522 2670 160
Capex/share (p) 91.4 67.2 99.1 186 198 235
Free cashflow/share (p) 219 942 581 1336 2472 -75.0
Net debt (£m) -119.0 66.9 280 153 -2091 -1879
Net assets per share (p) 499 576 507 1001 1240 1440
             
Source: historic Company REFS and company accounts            

Debt increase looks a short to medium-term drag

Consensus forecasts vary, but indicate £6 million net profit for 2019, with headline figures by exceptional costs, then a near £12 million loss targeted for 2020. I haven’t seen broker notes but expect this relates to Metro issuing £350 million debt last October at an eyebrow-raising interest rate of 9.5%, in order to meet regulatory needs.

While Metro attempted to wrest a positive, asserting demand from 60 institutions was strong enough to upsize from £300 million initially, but, logically, this says they exacted a high coupon for high risk. Moreover, Metro overly acceded to this by offering 9.5% which was then considered a steal.  

Unfortunately for existing shareholders this debt may have weighed on the equity, mitigating its ability to recover lately, although having added this debt to end-June balance sheet liabilities I derive NTAV per share of 690p.

It is more a nuisance in the stock recovery rationale than a ball and chain; the crux being the extent a new CEO can, as Metro says, “examine all means to enhance capital efficiency including asset sales.” In the course of my research I have come across guidance for £19 million annual run-rate savings by end-2019, in context of a £400 million annual cost base and before the current interim CEO taking over on 1 January.

A radical option which could yet attract the likes of an activist hedge fund might be to run the loan book off to another financial institution, close all the bank branches and make staff redundant (beyond those required to help service loans). That’s a speculative view but could represent a margin of safety given the discount to assets is so big. I target the stock to double in value along a rationale of re-rating to a circa 40% discount to NTAV.

Mixed if steadily improving, recent progress

A 23 October trading update in respect of third quarter 2019 was encouraging in the sense that, despite bad headlines early last year, total deposits rose £528 million to £14.2 billion with customer growth of 106,000 to 1.9 million.

Reflecting the stasis in UK consumer/business confidence amid a political fiasco, total net loans were broadly flat at £14.9 billion, hence the loan-to-deposit ratio reducing to 105% from 109% in the first half.

On an annualised basis, however, this represented around 13% growth in the loan book, some 70% oriented to residential mortgages, with the rest business lending. Barring a recession and a housing market slump, it is relatively low-risk lending, with a modest £200 million exposure to 90% loan-to-value mortgages.

My base case scenario is for the UK housing market to see a slow improvement this year before facing the real test going in to 2021, of how the economy copes with whatever trading scenario is agreed with the EU. It will be the same for UK business. So, demand for loans should be on a positive trend notwithstanding tough competition among banks.

Metro’s £6.7 million underlying pre-tax profit in the second quarter had dipped into a £2.2 million loss, reflecting actions to bolster the balance sheet. So, although the current outlook and share price appear to be in the doldrums, it now looks an interesting time to consider averaging into the stock, certainly on a rationale of “new CEO with scope for radical actions on Metro’s asset and cost base.” I target the stock to double along a rationale of re-rating to a circa 40% discount to NTAV.

Mixed upshots from a 7.3% short position

It is disquieting in the sense that Marshall Wace and ENA Investment Capital both raised their short positions very slightly to 1.1% and 3.1% of Metro’s issued share capital, respectively, although Odey Asset Management nearly halved its short to 1.9% early last December. I don’t take a dismissive approach to material shorting, assuming such a stock is a coiled spring for when hedge funds buy back: they will have a bear case and Marshall Wace is a seasoned operator in UK stocks, on the short side.

Yet, the most shorted company currently is Premier Oil at 20.3%: a position blown out the water this week by an innovative rights issue and acquisition of North Sea assets to cut debt.

Rival views as to bull/bear prospects underline how Metro remains speculative, where news arising needs close attention. All-considered, the NTAV discount and scope for a new boss to take radical actions tilt my stance to: Buy.

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

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