Why the RBS share price fell 9.1% in August

Fat dividends from Royal Bank of Scotland Group plc (LON: RBS) should reward patient shareholders, says Roland Head.

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Warren Buffett once described the stock market as “a device for transferring money from the impatient to the patient”.

What the billionaire investor meant was that we should ignore short-term share price movements and focus on businesses which offer long-term value. After a difficult August, I think this is a useful piece of advice for Royal Bank of Scotland Group (LSE: RBS) shareholders.

The RBS share price fell by 9.1% last month, more than double the 4% drop printed by the FTSE 100 index. Investors were discouraged by the bank’s downbeat outlook for 2020, which could impact profitability. But RBS itself remains in good financial health and I think the gloomy outlook may be masking a decent value opportunity.

2019 is looking good

RBS kicked off last month with its half-year results. These showed operating profit for the period up by 47% to £2,694m. The bank also announced plans to return £1.7bn of spare cash to shareholders through dividend payments in September.

Profit margins remained under pressure due to tough competition in the mortgage market. However, £173m of cost savings helped lift the bank’s return on tangible equity to 12.1% for the half year, compared to 5.3% last year.

2020 could be difficult

I think the 2019 figures were fairly solid. I suspect that what caused the shares to fall was the bank’s cautious outlook for 2020. CEO Ross McEwan repeated his previous warning that “continued economic and political uncertainty” is likely to make trading difficult next year.

In press interviews, he noted that large companies are repaying debt and sitting on piles of cash, waiting to see how Brexit turns out. According to Mr McEwan, many large UK companies are reluctant to borrow money or expand at this time.

As a result of these conditions, RBS isn’t expected to achieve its target return on tangible equity of more than 12% next year. City forecasts suggest that after strong growth in 2019, profits are likely to flatten out in 2020.

PPI blues

The final deadline for PPI claims on 29 August was meant to be a relief for banks. But claims management companies appear to have been working overtime to drum up new business. As a result, RBS issued a statement earlier this week warning that total claims are expected to be £600m-£900m higher than originally expected.

The good news is that this is the end of PPI. But these are real cash costs, so they could limit dividend growth over the next 12 months.

My view

The outlook seems to be increasingly uncertain. Recent UK economic data show slowing performance in both the manufacturing and service sectors. In addition to this, there’s the risk of disruption in the event of a no-deal Brexit.

However, none of this is a surprise. I think that most of this uncertainty is already reflected in the bank’s share price.

At 190p, the shares trade at a 35% discount to their tangible net asset value of 290p. Forecast dividends for this year give the stock a staggering 12% yield for 2019 and suggest an 8% yield for 2020. If delivered, these payouts could deliver a 20% cash return in two years.

As an income investor, I rate the stock as a buy and am happy to continue holding my RBS shares.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares of Royal Bank of Scotland Group. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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