‘Big Four’ FTSE 100 bank NatWest (LSE: NWG) has had a very troubled time recently.
It suffered a PR disaster following the ‘de-banking’ of former politician Nigel Farage by its private bank Coutts. Further negative news surrounded the departures of its CEO and then Chairman.
There is a risk, of course, that it may inflict further PR disasters on itself that deter some new customers. Another risk is that interest rates peak and then fall sooner than previously expected, so reducing profits.
However, what stands out for me in this is that its shares are 27% lower than their high this year.
And this for a major government-backed bank, with significant retail and investment banking operations at home and abroad.
But not just this. Because of its various PR disasters, most investors seemed to have overlooked the recent outperformance of its business.
Excellent H1 performance
Specifically, the bank made a pre-tax profit of £3.6bn in H1, compared to £2.6bn in H1 2022.
This was mainly due to the big difference between earnings from loans given out and payouts for deposits taken in.
These results enabled the bank to announce an interim payment for H1 of 5.5p – compared to last year’s 3.5p.
The final dividend for last year, though, was 30.3p per share. Based on a current share price of £2.30, this gives a whopping yield of over 13%!
Is it undervalued?
Just because a share has dropped dramatically in the past few weeks, months, or years, does not mean it is undervalued. It may simply be that the business itself is just worth less now than it was before.
To ascertain the true value of a company, I start with its price-to-earnings (P/E) ratio, and currently, NatWest’s is 4.7.
This compares to Barclays’ 4.2, Lloyds’ 4.9, HSBC Holdings’ 6.1, and Standard Chartered’s 8.8. All these FTSE 100 banks lag the benchmark index’s present trailing average P/E of 10.8.
This strongly suggests to me that NatWest is undervalued. So, what should its fair value be in share price terms?
In my experience, the best tool to provide the answer to this is the discounted cash flow (DCF) valuation. This involves making several assumptions about future cash flows and discount rates applied to those.
Given this, I do not rely on my own figures but look at several DCF valuations of a company. This gives me a good feel for the sort of price range I might be looking at.
For NatWest, the figures tend to range tightly, from around a 65% to 70% undervaluation for its shares in DCF terms.
Taking the lower point of this range would give the bank a fair value per share of £6.57.
This does not mean that the stock will reach that point, of course. It does underline to me, though, that it currently offers very good value.
There are certainly companies with a greater undervaluation in P/E ratio terms than NatWest. There may also be ones with an even more pronounced undervaluation in DCF terms.
Yet for me, the undervaluation and the strong fundamentals I see are compelling to me. Once I sell another of my financial holdings in order not to overweight the sector in my portfolio, I will buy NatWest stock.
