Barclays (LSE:BARC) shares are among my largest holdings. It’s one of the most undervalued stocks on the FTSE 100, offers a generous dividend yield, and has one of the strongest coverage ratios I’ve seen.
Despite this, it’s still not widely popular with investors. And the prevailing narrative — that this is the best it’s going to get for banks — is likely keeping the share price depressed.
And this is fine with me for now. Because, channelling my inner Warren Buffett, it gives me a chance to buy more of my favourite stocks at lower prices.
Pros and cons of higher rates
When it comes to banks, interest rates dominate the current conversation. When central bank rates increase, this allows commercial banks to increase their net interest margins — the difference between lending and savings rates. As a result, Barclays saw its net interest margin extend to 3.18% in Q1, up from 2.62% last year.
These higher margins propelled the banking giant during the quarter with group income rising 11% to £7.2bn, and pre-tax profit jumping 16% to £2.6bn. Earnings per share (EPS) came in at 11.3p — greater than the annual dividend for 2022.
But there’s a downside to rising interest rates, and that’s higher impairment charges — a process used by businesses to write off bad debt. In Q1, bad debt provisions increased to £524m from £141m a year ago. That largely reflected higher US cards balances and anticipated delinquencies, but continued rising rates in the UK will likely cause more pain.
Moreover, and as someone looking to take a mortgage, I can attest to the fact that higher rates are clearly off-putting. This impacts loan book growth, another concern on top of affordability.
So there are pros and cons to the current situation.
Forward yield
Barclays currently offers a 4.7% dividend yield. That’s above average for the FTSE 100, and a little above the average for its banking peers on the index. It’s also very sustainable. In 2022, the dividend was covered by income an impressive 4.25 times, making it one of the safest dividends on the index.
Going forward, we can assume that this dividend looks very safe for 2023. That’s partially based on the fact that Q1 EPS far outstripped last year’s dividends for the year as a whole.
This gives Barclays room to increase the dividend. Analysts are forecasting the company to pay a dividend of 8.6p per share in 2023, and then 9.7p per share in 2024. At the current share price, this would amount to forward yields of 5.7% and 6.4%.
I appreciate that banks are cyclical, but I’d still suggest there’s room for the dividend to continue growing beyond 9.7p. After all, a dividend coverage ratio above two is normally considered healthy.
My conviction in a strong forward yield is reinforced by the interest rate forecast. Analysts expect central bank rates to fall to a sweet spot between 2% and 3% in the medium term. During which, net interest income will remain elevated versus the last decade, but bad debt concerns should fall.
And this is why I’ve been buying more Barclays shares. It’s one of several dividend stocks that I believe are a steal right now.
