Companies analyst Edmond Jackson explains why he is bullish on this bank as a long-term holding, despite little prospect of a dividend for a while.
After examining the largest listed banks, it is timely also to review the situation at “challenger” Metro Bank (LSE:MTRO), which yesterday published its 2022 results. A stock price of 144p implies a capitalisation sub-£250 million versus £35 billion for the likes of Lloyds Banking Group (LSE:LLOY), one reason for more leverage if the shift to higher interest rates lasts.
The stock fell massively from over 4000p in 2018, but was inflated after expanding too fast and hopes running high.
The numbers were broadly in line and consensus targets earnings per share (EPS) of 15p in 2024, based on £24 million net profit. Sentiment is balanced between intrinsic value still having attractions, versus fear that progress would be compromised by a recession reducing demand for mortgages and loans, with some extent of write-offs.
In response to the results, its share price fell by 4%, although it recovered 3% to 147p in early dealings today.
I made a recovery “buy” case last November at 80p, noting a £143 million valuation was an 81% discount to £742 million net tangible assets (NTAV) on last June’s balance sheet – versus a circa 10% discount at big-name banks.
Despite little prospect of a dividend for a good while, I thought that if the market sensed a sustainable return to profitability, the NTAV discount should reduce over time. Currently it is around 66% with NTAV easing slightly to £740 million, but a 10% discount implies a stock target of 400p.
‘A successful transformation’ albeit ‘material headwinds’
Underlying profitability was achieved in the fourth quarter although consensus remains for a minor net loss this year. So much depends on the UK economy where even Bank of England forecasts have proven erratic.
Dan Frumkin, its CEO, described 2023 as a “transitional year”. This may come across limply to enterprising investors likely holding Metro equity. He says: “The bank will focus on serving customers and maintaining cost discipline, while continuing to invest in infrastructure and build sustainably.”
But “transitional” can come across quite like the proverbial “year of consolidation”, as if to temper hopes.
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Frumkin also said: “While I remain confident in the underlying business, material headwinds do exist, including the macro-economic environment and increasing competition for liabilities.” Perhaps companies and individuals are backing off fresh debt; meanwhile there is no shortage of lenders.
If “muddle through” is a fair scenario for the UK economy, then Metro appears resilient. I think the chief spoiler would be inflation staying way above the Bank of England’s target, as wage awards kick in; then further interest rate rises create a recession. You need to believe that inflation can ease sufficiently in the developed world without central banks doubling down like they did in the 1980s.
Mortgages have risen from 54% to 58% of the lending book
While commercial loans eased 12% over the year to £2.8 billion, retail mortgages jumped 14% to £7.6 billion. Might businesses be the more reliable forward indicator of demand? This also supports my point how prudent borrowers are deleveraging.
Perhaps the hike in mortgage lending chiefly reflects average UK house prices rising over 10% last year, and inflation-linked pay supporting greater mortgage debt. Such extent of exposure to the housing market leaves no room for a slump.
Major housebuilders report weaker sales and reservations this year, as the market is cooled by higher interest rates; yet there are also signs it may be picking up after demand slumped at the end of last year. Springtime is traditionally strong.
After a 31% increase in Metro’s 2022 total underlying revenue, consensus for a 15% advance this year assumes demand for mortgages and loans will not get hit. Also helping is an improvement in net interest margin – the difference between what is earned from borrowers and paid out to depositors – rising from 1.4% to 1.9%. Lloyds has reported just over 3.0%, hence a capable management should grind Metro’s margin higher.
Return on net tangible equity is guided at low-to-mid single-digit per cent by 2024; which likewise shows scope to improve, versus Lloyds on 13% as a comparator for exposure to the UK economy.
Might excess savings from the 2020-21 lockdowns, tidy people over?
Twin reasons why a UK recession has yet properly to materialise are that those in work are enjoying decent security in a tight labour market; and excess savings are providing a cushion.
Rishi Sunak’s “most generous furlough scheme in the world” added to national debt but meant a radical improvement in household finances while their spending was cut. Some enterprising souls appeared to odd-job as well.
Apparently, there are £250 billion excess savings in the UK yet to be drawn on, providing valuable downside protection to behaviour and confidence. One consumer confidence index is at its highest level since March 2022, and we have seen strong Christmas trading updates from various consumer-facing companies.
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Helping explain the recent rebound in banks: financial equities often take their cue from where the economy is broadly heading.
Moreover, and in terms of Metro’s exposure to mortgages, an interesting report from Savills on the UK housing market cites a 38% majority of UK households owning their home outright, than 33% via a mortgage; and the average loan-to-value on mortgaged properties has fallen from 49% in 2012 to 38% in 2022.
Combined with an extent of fixed-price mortgages that will take years to fully roll off, it means the increases seen in mortgage rates will have less impact on consumer disposable incomes than generally assumed.
The upshot of such macro observations are bullish for Metro equity, raising the odds that management continues to cut a successful turnaround.
Metro Bank - financial summary
Year end 31 Dec
|Turnover (£ million)||120||195||294||404||422||434||420||531|
|Operating profit (£m)||-56.8||-17.2||18.7||40.6||-131||-311||-245||-70.7|
|Operating margin (%)||-47.3||-8.8||6.4||10.0||-31.0||-71.8||-58.3||-13.3|
|Net profit (£m)||-49.2||-16.8||10.8||27.1||-183||-302||-248||-72.7|
|Reported earnings/share (p)||-61.3||-21.8||12.6||28.3||-124||-175||-144||-42.2|
|Normalised earnings/share (p)||-53.0||-17.2||13.9||31.6||-89.6||-122||-116||-35.3|
|Operating cashflow/share (p)||680||1,522||2,670||160||-1,109||604||1,655||-687|
|Capital expenditure/share (p)||99.1||186||198||235||135||63.8||47.0||30.7|
|Free cashflow/share (p)||581||1,336||2,471||-75.1||-1,244||552||1,608||-718|
|Net debt (£m)||280||153||-2,091||-1,879||-1,807||-1,870||-2,542||-899|
|Net assets (£m)||407||805||1,097||1,403||1,583||1,289||1,035||956|
|Net assets per share (p)||507||1,001||1,240||1,440||918||748||600||554|
Source: historic company REFS and company accounts
Has Crispin Odey fallen in love with a long-term successful ‘short’?
The high-profile hedge fund manager made a very astute call on downside risk: being short around 4% of Metro’s issued share capital four years ago as it fell from circa 2000p.
I would have thought it made sense to at least trim such a position – there are currently no other hedge funds over the 0.5% disclosure level – unless his Metro short is specifically a hedge against the UK economy for wider portfolio protection.
Indeed, Odey Asset Management cut its short from 3.2% a year ago to 2.2% as of last November; but then raised it over 4.0% in December and was 3.7% as of 13 February.
Quite whether any investment committee flinches to challenge the boss’s conviction; but if Metro’s turnaround broadly continues to evolve and the UK dodges a serious recession, there is potential here for quite a short squeeze.
Call option on the UK economy?
That would be a harsh verdict when the stock’s discount to net tangible assets is arguably a margin of safety. Yet Metro remains speculative, not investment grade, until it establishes earning power sufficient to pay dividends.
For now, you do indeed take a view on the economy, takeover potential also. I temper near-term enthusiasm after an 80% rally, but consider the long-term stance remains: buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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