Why I’ve turned bearish on Barclays plc

Roland Head explains why he’s dumped Barclays plc (LON:BARC) and highlights another stock on which he’s bearish.

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When I last wrote about FTSE 100 banking group Barclays (LSE: BARC), I viewed the stock (which I held) as a value play trading at an attractive discount to book value.

That discount is still available, but following the bank’s recent third-quarter results I changed my mind about the stock and sold my shares. I’ll explain why later in this article, but first I want to look at another popular stock with results out today.

A booming market

Car auction group BCA Marketplace (LSE: BCA) has done very well as new car sales have rocketed in recent years. Today’s half-year results show that revenue rose by 29% to £1,171.6m during the six months to 1 October, while operating profit climbed 22% to £40.9m.

The only problem is that after a long period of growth, the car market may be heading for a downturn.

According to the Society for Motor Manufacturers and Traders (SMMT), new car sales were 12.2% lower in October than they were one year ago. It’s the seventh consecutive month in which registrations have fallen. New car registrations are now down by 4.6% so far this year, and used car sales are also falling. After a strong start to the year, used car sales fell by 13.4% during Q2 and by 2.1% during Q3, according to SMMT figures.

Heavily exposed

My concern is that BCA isn’t doing enough to prepare for the risk of a serious slowdown.

Net debt rose to £287.4m during the first half, as investment in growth continued. In addition, the amount of finance extended by the firm to trade buyers rose by 55% to £123.7m. Stock inventories hit a new high of £71.6m. The value of the firm’s inventory has now risen by a staggering 270% over the last 18 months.

My view is that in chasing growth, BCA is taking a lot of risks. If the car market does continue to slow, I believe the group’s slim 3.5% operating margin could be crushed. Debt levels could rapidly become problematic.

In this context, I think BCA’s P/E of 20 times forecast earnings is too high. I’d also suggest that today’s 18% dividend hike might be too generous. I’d rate this stock as a sell.

Why I ditched Barclays

Barclays’ recent third-quarter results highlighted the risk of investing in turnarounds. Sometimes these stocks are cheap for a reason. Eight years after the financial crisis, the banking group’s return on tangible equity — a key measure of profitability for banks — was -1.4% during the first nine months of 2017.

Excluding various items, including a £700m PPI charge, this figure rose to 7.1%. Barclays’ hope is that this figure will rise to “above 9%” by 2019, excluding possible misconduct charges and litigation costs. The bank is targeting 10% for 2020.

These targets seems fairly unambitious to me. Rival Lloyds Banking Group is already achieving an adjusted return on tangible equity of 10.5%. HSBC Holdings is at 8.2%.

If this is as good as it’s going to get for Barclays until 2020, then I’d argue that the upside potential on offer is probably less than I’d thought. In the meantime, shareholders still have to face the risk of underperformance and further legal problems.

For these reasons, I have sold my shares and invested the cash elsewhere.

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 has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays, HSBC Holdings, and Lloyds Banking Group. 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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