It is fair to say that Metro Bank does not talk like other lenders. For example, it does not have customers, it has FANS. Where other banks make bold claims for their service, Metro goes further. Not content with providing a somewhat better offering than others it claims for itself an “AMAZEING culture” fostered by the “AMAZEING behaviours” of its colleagues – which is what it calls its 3,000-strong workforce.
And the valuation? That is pretty amazing, too. Where Lloyds Banking Group trades at a book value of 1.3 times the value of its assets, Metro Bank is well above 3 and is heading higher. The more than 50 per cent rise in the value of the shares since the April 2016 flotation means that Metro is easily the largest so-called challenger lender by market capitalisation, worth a little over £3 billion, nearly £2 billion more than Virgin Money, which has trebled deposits and makes more than ten times what Metro does in profits.
What is most remarkable is that Metro has achieved this exalted valuation while consistently delivering losses. This year’s statutory profit is the first since the bank opened its doors eight years ago, meaning that perhaps the most AMAZEING thing about the lender is the patience of its investors and, incidentally, of whom more than 80 per cent are based in the US.
To own Metro, therefore, you have to make some heroic assumptions about the growth of the business, something the bank is understandably more than happy to stock. So while deposits today might be £11.7 billion, by 2020 the target is to more than double them to close to £28 billion, with an aim to exceed £50 billion by 2023.
Similarly, while return on equity today is a measly 1.2 per cent, compared to 8.9 per cent offered by Lloyds and more than 12 per cent at Virgin Money, Metro says it will reach 14 per cent within three years and as high as 19 per cent in 2023.
Craig Donaldson, chief executive of Metro Bank, is certainly enthusiastic about his business’s prospects and points out that, with 0.4 per cent of the British deposit market, the lender has plenty of space to grow: after all a 4 per cent share would equate to more than £100 billion of deposits.
Of course, while Metro Bank has had success in winning over customers switching from one bank to another, particularly in the business banking market, it is not the only one out there trying to lure people away from the established high street banks.
Then there are the costs. From 55 branches, or stores as Metro insists on calling them, the bank expects to open a further 12 sites this year with a target of about 100 by 2020 and as many as 160 in 2023.
However, high street branches do not come cheap and the bank puts the cost of fitting out a new site at between £2 million and £4 million. On that basis, the minimum expenditure to open 45 new branches will be £90 million, and potentially well in excess of £100 million.
Whatever the doubts, the City clearly loves the Metro strategy of “bricks and clicks” and Vernon Hill, the bank’s co-founder, has proved a master of hype. To be fair to Mr Donaldson and to Mr Hill, they have thus far proved the doubters wrong, but just standing back and looking at the figures requires an enormous leap of faith to justify the current valuation.
The next three years will be critical. Having started to deliver on its promises, Metro must show it can maintain the momentum. For the present a sensible approach would be to hold off and wait to see whether 2017 is the beginning of the good times, or the point at which reality finally caught up with the market.
Advice Hold
Why Its delivery has been impressive but the valuation is still far too high to justify buying now
AA
It was bonuses all round three years ago at Cenkos after the broker pulled off what appeared to be the deal of the year. It cleverly had pulled together ten cornerstone investors to back a management buy-in and flotation of the AA, the roadside rescue business.
Bob Mackenzie, the star who put the oomph into Green Flag, was parachuted in to lead the business, while a string of big-name backers such as Aviva, Blackrock and Legal & General were there to provide the financial firepower. What could possibly go wrong?
Well, Mr Mackenzie ended up in an alleged brawl with a senior colleague and was dismissed for gross misconduct, while the business, weighed down with the best part of £2.8 billion in debt, struggled to make any progress at all and continued to lose members.
More than £1 billion of equity value has been destroyed. The shares, floated at 250p, now trade at 84p. Belatedly, Simon Breakwell, the new chief executive who has been on the board since 2014, thinks there needs to be a step change in investment. That means slashing the dividend from 9.3p to 2p to avoid a breach in loan covenants. Suddenly, a juicy income stock yielding 5, 6 or 7 per cent looks far less appetising.
The balance sheet is the No 1 concern. Mr Breakwell’s additional investment in the actual breakdown service should prevent a further fall in customer numbers, while his experiment with new telematics technology and a deeper push into general insurance may or may not deliver lasting benefits.
What is certain is that the AA still has the burden of managing and gradually reducing its mountainous debts. The first tranche of £500 million is due for refinancing in 2020. It pays 4.25 per cent on these notes and believes that it should be able to refinance on keener terms.
The “buy” case is that the AA is in effect a juggernaut-sized equity-for-debt swap, but what happens if there is a steeper than expected increase in market interest rates? Leverage works both ways. Even a modest improvement in the underlying business could produce a disproportionate boost to the share price.
Advice Hold
Why Strong cash generation and brand but debt a big worry
