Banking is possibly the most hated sector in the market and it’s easy to see why. Low interest rates are squeezing profits, regulations are pushing up costs and a pull-back from trading is rendering formerly lucrative trading floors redundant.
These pressures have pushed bank stocks down to lows not seen since the financial crisis. However, compared to the situation eight years ago, banks are much stronger with larger capital buffers and risk controls.
Barclays (LSE: BARC), for example, has transformed itself since the financial crisis but today its shares trade at a five-year low. Granted the bank has had a tough time during the past few years with earnings per share collapsing by as much as two-third since the 2012 peak, but City analysts expect growth to return next year.
Indeed, as the bank’s restructuring finally takes hold under new CEO Jes Staley, City analysts are predicting a 60% leap in earnings per share for 2017.
Part of this jump in profitability is to do with the wind-down of Barclays’ restructuring. Barclays has closed 117 of its 1,448 branches in the UK in the past year. It has also shed 11,000 of its 130,000 staff since Mr Staley imposed a hiring freeze and closed its operations in nine countries. Restructuring costs hit profits at the bank by £887m during the second quarter, dragging pre-tax profits down 18% to £1.3bn.
Mr Staley has made it clear that these restructuring costs won’t be replicated next year. In fact, he’s said that restructuring costs will disappear and Barclays’ return on average tangible equity will hit its double-digit target next year. For the second half, return on average tangible equity was 5.7%, well below target.
If Barclays does meet City expectations for growth and hits management’s return on equity target, then there could be a significant rally in the shares.
Cheap for a reason
Shares in Barclays are cheap, there’s no other way of saying it, but the bank has consistently disappointed investors and missed targets during the past few years.
These disappointments have pushed the shares down to a huge discount to tangible net asset value. At the end of the first half, Barclays’ tangible net asset value was 287p per share so, at time of writing, the shares are trading at a price-to-tangible book value of 0.6.
It’s this discount that implies to me that shares in Barclays could be one of the most undervalued stocks in the FTSE 100. If the bank hits its recovery targets next year, there could be a massive recovery in the shares too.
Renewed investor confidence
So a rebound in investor confidence could re-rate the shares to tangible book value, a potential upside of 60%. Further growth would pull shares in the bank higher than this level. For much of the past 12 months shares in peer, Lloyds have traded at a premium to tangible book value, and there’s no reason why, if growth targets are met, Barclays can’t match this valuation.
