Interactive Investor

Stockwatch: why the economy could let this ‘deep value’ bank stock flourish 

23rd May 2023 10:25

by Edmond Jackson from interactive investor

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If the UK economy can muddle through, analyst Edmond Jackson suggests a decline in share price at this lender is another chance to consider buying. 

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    If you hold any bank equities, be forgiven for exasperation at their volatility – occasionally at odds with the company’s statements. It is broadly because the financial sector – including insurance companies and fund managers – is at the forefront of expectations changes towards the economy, which in recent months has wavered between ‘recession-on, recession-off’. 

    Yet scope remains for company analysis, and mean-reversion from extremes will always characterise equities. That is my sense of market efficiency. 

    Metro Bank Holdings (LSE:MTRO) is a focused example, partly as a £180 million small-cap and also given a volatile operating history as a “challenger bank”. It grew rapidly after founding in 2010 but hit trouble in 2019 after errors in accounting for commercial loans – as part of regulatory needs. Vernon Hill, the American co-founder, also created controversy, and an overall credibility issue led to a run on the bank’s deposits, hence a slump in its equity from over 4,000p five years ago. 

    After a break with previous top management in 2020, scope for mean-reversion intrigues me – though it is taking time and has become conflated with economic fears. 

    A rollercoaster since I backed the shares six months ago

    I suggested “a case exists for at least a starter position” around the 80p price last November – an 81% discount to net tangible assets, hence pricing in significant loan-impairment risks in the event of a recession. 

    At least some extent of interest rate normalising from very low levels since 2009 should benefit banks’ operating models, although demand for loans and mortgages will also be key. 

    Three directors had bought £208,000 worth of equity at prices in the low 80p area up to 90p, and a third-quarter update cited profitability returning sooner than expected in September, versus previous guidance for the first quarter of 2023. 

    Metro shares rose steadily to 153p by mid-February, but in March reversed this trend, dropping back to 93p as recently as 17 May.  

    This was despite a 3 May trading update showing the first quarter of 2023 as a second consecutive one of underlying profitability. 

    Forecasting will be sketchy given economic uncertainties, but consensus expects a 2022 net loss of £73 million, improving to a £9 million profit this year, then £34 million in 2024 – on which basis, with the stock currently around 104p the forward price/earnings (PE) multiple would drop from around 15 times to near five.  

    There are no dividend prospects, however, compared with Barclays (LSE:BARC) offering 6% covered 3.7 times by earnings (if consensus is fair), and Lloyds Banking Group (LSE:LLOY) offering 6.2% covered around 2.6 times.  

    So if the UK economy can muddle through, I suggest this latest drop – now attracting investor support – is another chance to consider buying. 

    Mixed profile of financial assets involved seasonal factors 

    At 31 March, assets were broadly unchanged versus end-December at £22.1 billion. Loans edged 1% lower at £12.9 billion and deposits by 3% to £15.6 billion “reflecting seasonal factors such as tax payments in January, offset by net inflows in March.” 

    More positively, deposits saw continued growth as over 54,000 new personal customer accounts and 12,000 business accounts opened during the quarter. Overall current account openings jumped 18% like-for-like and were 20% higher than the first quarter of 2020, pre-Covid. It looks like competitive strength with people changing bank. 

    In line with the context of a soft UK economy, total lending of £12.9 million was broadly flat, with retail mortgages up slightly to £7.7 billion – offset by falls in consumer lending to £1.4 billion and commercial to £3.9 billion.  

    This profile implies the housing market will remain a significant influence on Metro, which dials back to a macro question: can the Bank of England tame inflation such that interest rates – and by implication mortgage rate rises – do not stall demand? 

    Metro Bank - financial summary
    year end 31 Dec20152016201720182019202020212022
    Turnover (£ million)120195294404422434420531
    Operating profit (£m)-56.8-17.218.740.6-131-311-245-70.7
    Operating margin (%)-47.3-8.86.410.0-31.0-71.8-58.3-13.3
    Net profit (£m)-49.2-16.810.827.1-183-302-248-72.7
    Reported earnings/share (p)-61.3-21.812.628.3-124-175-144-42.2
    Normalised earnings/share (p)-53.0-17.213.931.6-89.6-122-116-35.3
    Operating cashflow/share (p)6801,5222,670160-1,1096041,655-687
    Capital expenditure/share (p)99.118619823513563.847.030.7
    Free cashflow/share (p)5811,3362,471-75.1-1,2445521,608-718
    Cash (£m)2825002,2122,4722,9892,9933,5681,956
    Net debt (£m)280153-2,091-1,879-1,807-1,870-2,542-899
    Net assets (£m)4078051,0971,4031,5831,2891,035956
    Net assets per share (p)5071,0011,2401,440918748600554
    Source: historic Company REFS and company accounts

    Macro issues remain principal driver of the stock 

    Metro’s 10-week de-rating from 153p to 93p occurred with no negative news, although the CEO did hedge his outlook statement with caution at the 2 March annual results: 

    “While I remain confident in the underlying business, material headwinds do exist, including the macro-economic environment and increasing competition for liabilities. We have established the basis to transition back to being a profitable growth engine...”  

    It was not the proverbial “much remains to be done” in turnaround situations, more an admission any bank is hostage to the economy. With Metro on the cusp of resuming profitability, yay or nay could weigh more significantly on sentiment. 

    Yet Barclays also fell from around 170p to 135p and Lloyds from 52p to near 45p. Insurers and fund managers also dropped, so it’s fair to assume a wider sentiment shift.  

    Metro’s 13% jump in recent days has happened without any material company news or indeed much revelation on the economy, which I think shows the market remains alert to scope for upwards mean-reversion. 

    With the end-2022 balance sheet showing net tangible assets little changed at 429p per share, the discount is near 76%. 

    Even Crispin Odey is reducing longstanding short exposure

    Disclosed short-selling of Metro shares soared from 3.5% of its issued share capital in mid-2018 to 12.5% a year later, but after some volatility during the Covid years, it has eased currently to 4.8%. That is still material, although for a small-cap stock is small in the context of hedge fund portfolios. 

    Significantly, Odey Asset Management’s last change in its position was a 0.9% reduction to 2.2% as of 29 March, while ENA Investment Capital edged theirs up to 1.6% in June 2020 and Connor, Clark & Lunn trimmed theirs just below 1% at the same time.  

    Odey has been a longstanding, successful short-seller of Metro, but halved that position from last December and reportedly opined the bank could be taken over by a rival. 

    Trades below cash if you like ‘deep value’ equities  

    Exponents of this ‘deep value’ approach would say, tuck a few shares away and be patient. Applying such a screen as derived by US investor and writer James Altucher, Metro meets all six of his checklist rules for “trading below cash”.  

    The end-2022 balance sheet had nearly £2 billion cash and balances with the Bank of England, some of which is likely for regulatory needs but is still cash; and is separate from £16 billion customer deposits versus just over £13 billion loans.  

    A simple way to try and reconcile how useful this is likely to be is to compare with customer ratings. Bare financial bones are one thing, but marketing remains a company’s flesh and blood. 

    While Metro’s customer growth figures are encouraging, 4,228 Trustpilot reviews derive a 2.4 out of 5.0 rating – with 48% on 5-star versus 45% on 1-star. I would factor in that online reviews can be a foil for complainants which virtually any business will get. Barclays rates 1.4 out of 5.0 with 8,538 reviews, 86% on 1-star; and Lloyds rates 1.6 based on 3,651 reviews, 79% 1-star. 

    Mine is a simple approach but at least implies an element of customer switching to Metro, therefore improving the odds a ‘deep value’ screen will prove long-run successful. Buy.

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

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