Barclays has seen the back of Edward Bramson, the activist investor, but it’s having a harder time convincing remaining shareholders of the merits of its universal banking model. Its stock has been whacked with a much stingier valuation than those of Lloyds and NatWest, its closest publicly listed peers.
On the surface, conditions are brighter for shareholders than they have been for many years. A much lower level of impairments — of only £120 million, compared with £608 million this time last year — boosted pre-tax profits by almost three quarters during the three months to the end of September. That was some way above analysts’ expectations.
The regulatory capital position is above the bank’s own target, too, implying about £5.8 billion in surplus equity, according to estimates by Shore Capital, the broker. It announced a £500 million share buyback in July and analysts expect a total of just over £1.2 billion for this year. That’s alongside a dividend of 6p a share, which, at the present price, would leave the shares offering a decent potential yield of almost 3.1 per cent.
There’s also the potential fillip of an increasingly likely rise in the base rate. A 25-basis-point rise in interest rates could boost Barclays’ net interest income by about £275 million over a year and by £525 million over the next three years, according to the lender’s own estimates.
Too sharp a rise in rates risks making debt repayments unaffordable for customers, causing a rise in impairments, but swap rates — the difference between the bank rate and that at which it lends to customers — are rising. Net interest margins have been wafer-thin for Britain’s banks for more than a decade, so a nudge up in rates would provide a much-needed boost to profitability in the UK.
And, of course, Barclays’ investment banking fees were the highest on record for a third-quarter period, amid a corporate dealmaking boom that similarly propelled earnings for the bank’s Wall Street rivals. Pre-tax profits for the corporate and investment banking business increased by almost half over the first nine months of the year, while a return on tangible equity of 16.4 per cent vaulted that typically recorded in recent years.
So why the sullen faces? British investors are mistrustful of the earnings-generating potential of the investment banking business, so unpredictability of the income stream means that any outperformance is rarely given much credit.
One of the big unknowns is when the dealmaking frenzy will ease. There have been gains from the woes of Credit Suisse and Deutsche Bank and it’s that, rather than Barclays actively winning share, that has boosted investment banking income, according to RBC Capital. Add to that the oscillating markets of the past 18 months and you can understand why investors might be sceptical that buoyant market activity will continue. If income does ease, those investors may become less tolerant of a business that incurs higher costs and is not pulling its weight. On that note, Jes Staley, the chief executive, might trumpet the synergy potential of the One Barclays strategy, but, at 64 per cent, the cost-to-income ratio falls short of its own target for below 60 per cent.
Pre-tax profits next year are forecast to decline to £6.5 billion, from an elevated £7.6 billion anticipated for this year. The shares trade at a 31 per cent discount to the tangible net asset value forecast by analysts at the end of this year and failed to register any enthusiasm on the back of the third-quarter figures. Barclays is unlikely to get any real credit from investors any time soon.
ADVICE Hold
WHY Greater volatility in investment banking income means the shares’ discount to peers is deserved
Dechra
Dechra can’t afford to show any signs of weakness. A boom in pet ownership and the amount that people are willing to fork out for their animals has supercharged revenue and profit growth for the pet pharmaceuticals specialist. That’s left the shares with an eye-watering forward price-earnings ratio of 44 — a valuation that’s near a record high.
It’s only natural, then, that investors applauded the company’s latest reassurance that market demand, particularly in the United States, had remained strong since the end of June.
In an animal health market dominated by large players focused on mass-market products such as flea and worming treatments, Dechra has carved out a niche, prescription-only drugs business primarily for dogs, cats and horses. It has three avenues for profit growth: new product development; bolt-on acquisitions; and expansion into markets where emerging wealth is willing to spend more on pets.
Lockdown switched profit growth into a higher gear — “companion animal” products, which account for just under three quarters of group turnover, boosted revenue by about a quarter last year — but further growth faces a challenge: the (quite likely) chance that the attractions of pet ownership during lockdown subsides. Zoetis, the market leader in America, has already flagged a slowdown in the rate of demand during the second half of the year.
R&D spending is typically steady as a proportion of revenue at about 6.5 per cent. But selling and general operating expenses should return to 60 per cent to 70 per cent of pre-pandemic levels as sales reps get back on the road. Liberum forecasts about 80 basis points of margin erosion this year, against an underlying operating margin of 26.7 per cent last year. There’s also the threat of supply chain disruption. Products in short supply include antibiotics, primarily sourced from China and used in the manufacture of treatments. Dechra is holding more inventory in an attempt to stave off the threat of running out of stock.
However, manifold risks aren’t reflected in the shares, which remain priced for perfection.
ADVICE Avoid
WHY Shares exposed to a sell-off if there are any hints of weakness in earnings
