At the time of writing, the Metro Bank (LSE: MTRO) share price looks deeply undervalued. It’s trading at a price to tangible book value of just 0.2, implying the stock is undervalued by around 80% on that basis. Most profitable companies deserve to trade at or around book value.
However, as I explained last time I covered the challenger bank, Metro’s accounting scandal, which was revealed earlier this year, has shaken confidence in the business.
What’s more, the scandal has raised the prospect the bank doesn’t actually know how much its assets are worth. That suggests the published book value might not be an accurate representation of its balance sheet position.
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Moving on
Metro is trying to move on from its mistakes, but progress is slow. Last month, the company announced its chairman and founder Vernon Hill will be stepping down at the end of the year following pressure from bondholders. The bank has also been trying to raise more capital to bolster its balance sheet.
Investors initially rebuffed Metro’s first attempt to increase its capital position by £350m, using senior non-preferred loans (with an interest rate of 9.5%). The market relented when Hill stepped aside. The firm got the issue off the ground with an interest rate of 10%.
In a time when many companies across Europe can borrow money at a negative rate of interest, the fact that Metro has had to offer investors 10%, clearly shows those investors are sceptical. Probes into the bank by the Financial Conduct Authority and the Prudential Regulation Authority continue.
Meanwhile, Metro is facing an increasingly hostile business environment with falling interest rates and rising loan impairments. All of its peers are having to deal with the same issues, but at least they’re starting from a stronger financial position.
Growth slowdown
Since its IPO in 2016, investors have always viewed Metro as a growth enterprise, and so have its customers and managers. Now that the business is on the back foot, I’m sceptical it can ever return to its former glory.
The accounting scandal earlier this year seriously affected the bank’s reputation. Customers voted with their feet, pulling £2bn of deposits, weakening its growth and profitability metrics. Metro now faces an uphill struggle to attract new customers. And it’s going to have to do this while restructuring the business.
Overvalued
While shares in Metro might look undervalued on a book value basis, from an earnings perspective, they look quite expensive. City analysts believe the bank will report earnings per share of 12.6p for 2019, rising to 13.9p in 2020. Based on these targets the stock is currently trading at a 2020 P/E of 14.2, roughly double the UK banking industry sector average.
With so many headwinds buffeting the business, I’m not convinced the stock deserves this multiple. I think a more reasonable valuation would be around seven times earnings — in line with the rest of the sector. On that basis, there’s a good chance the stock could fall another 50% from current levels.
Even if it doesn’t, I think there are plenty of other stocks out there that offer a much better risk/reward profile.
