“RBS believes that it would be necessary to re-domicile the bank’s holding company and its primary rated operating entity to England,” Royal Bank of Scotland (LSE: RBS) (NYSE: RBS.US) said on Thursday. That will be the likely outcome if the Scots vote Yes.
Did you expect anything different from a bank that has been majority-owned by the UK government for almost six years? Other banks released similar statements this week, of course.
Upside At RBS?
Back to more serious issues: how much is RBS worth in this environment?
A colleague of mine has suggested that RBS stock could rise to 440p, for an implied 26% upside from its current price. Under a best-case scenario, I think such a price tag may be reasonable into the first half of 2015 if RBS management continue to deliver, but several elements must be considered in order to assess this investment case.
Elements To Watch
1) Bad bank (RCR): Guidance for losses at RCR has materially improved this year to up to £3bn from up to £4.5bn. If guidance improves further, the shares will rally.
2) De-leveraging: RCR and the Corporate and Institutional Banking business are doing well on this front. They should continue to do so.
3) Capital: RBS must be able to meet targets and generate excess capital in the region of £20bn by the end of 2016 in order to attract new investors.
4) Impairments: Impairments may still be an issue, although the bank’s impairment cycle may have bottomed out, as I recently argued.
5) Revenue: prospects have not improved significantly, so improved profitability will come from a lower cost base. Most banks have similar problems.
6) Stock overhang: The government still holds a large stake in the bank, and its exit strategy is unclear. Its total economic ownership stands at 80%.
RBS stock is still cheap, but is cheap for good reasons. The bank has yet to prove it can be profitable and pay dividends. Still, I think RBS management should keep doing what they have done in recent months to deliver value to shareholders. In short, RBS should hold less risky assets on its balance sheet.
The bank’s restructuring plan is slowly getting traction, and that’s reflected in RBS stock’s valuation, which is more attractive than that of rivals. To get the shares to a valuation of 440p, however, RBS should try and surprise the market just like it did in July, when the bank reported a trading update that helped its stock rise by 13% on a single day of trading. RBS as well as other banks in the UK also need a more accommodative monetary policy from the Bank of England, which is expected to start to raise its benchmark interest rates early next year. That’s not a given, though.
The way things stand, and based on its relative valuation, RBS remains my favourite pick in the ailing banking sector.
