It has been difficult to view Barclays’ valuation gap as an opportunity. A slump in investment banking activity, a higher cost base and a reputation for litigious surprises have held back the lender’s performance.
Barclays’ shares traded at a 56 per cent discount to its tangible net assets at the end of September, which scarcely falls to 55 per cent below the TNAV forecast at the end of this year. That is wider than any other London-listed lender.
A strategic review of its costs and structure has been trailed for February. The bank is reportedly devising plans to cut costs by as much as £1 billion over several years, which may result in the loss of between 1,500 and 2,000 jobs across the group. Barclays has declined to comment.
It is not surprising that the Barclays boss has been pushed to take action. The shares are lower since CS Venkatakrishnan was appointed two years ago. Missteps, like a £1 billion blunder discovered last year, have not helped. That revealed that Barclays had issued about $18 billion more securities in the US than it had permission for.
Yet the FTSE 100 constituent’s steep and stubborn discount is also grounded in the shaky performance of its investment banking operations.
About two-thirds of Barclays’ capital is allocated to the group’s investment banking operations. Parking more capital alongside its riskier investment banking activities was an easier sell in an era of uber-low interest rates, when the prospect of higher returns might justify the additional risk. Now even vanilla lenders like Lloyds have managed to turn out double-digit returns.
Even in boom times the market is reluctant to ascribe much credit to an income stream that is highly unpredictable. In tougher times, higher costs and capital guzzling are even harder to stomach.
Income generated by its investment banking business continued to decline during the third quarter, even if a 6 per cent year over year fall was much less severe than the 21 per cent suffered during the second quarter. The market downturn has resulted in less corporate deal-making activity as well as trading.
There is also work to do on the costs within its UK banking operations. A cost-to-income ratio of 56 per cent during the third quarter for Barclays UK was higher than ratios of just below 50 per cent for both Lloyds and NatWest.
The sugar hit of rapidly rising interest rates is also fading. Last month, Barclays warned that its net interest margin this year would be between 3.05 per cent and 3.10 per cent, lower than the 3.15 per cent guided towards in July as deposit funding costs rise.
Admittedly, Barclays is hardly short of capital. At the end of September, the bank’s common equity tier one capital ratio stood at 14 per cent, at the top end of management’s target range. And impairments have also been kept in check, coming in at £433 million in the third quarter, lower than the consensus forecast.
The strategic review will provide investors with a clearer idea of the lender’s capital allocation. That should include shareholder returns. Jefferies expects annual share buybacks of £2.2 billion next year and in 2025. The investment bank forecasts a dividend of 8.7p a share this year and 9.5p next year, which would translate to a yield north of 6 per cent, based on the current share price.
Cost cuts will not be pain free. A return on equity target of more than 10 per cent for the year excludes any charges that might stem from its strategic review. Analysts at Jefferies think the charges will amount to £750 million during the fourth quarter, but with a three-year payback period. Another turn in financial markets could derail progress in feeling the benefits of its review.
Any progress on closing the Barclays discount is likely to be slow.
Advice: Avoid
Why: The shares deserve a steeper discount than peers
Halfords
The magnitude of Halfords’ valuation decline might not be as harsh as it seems. The cycling and motor retailer has warned that underlying pre-tax profits are now expected to come in at between £48 million and £53 million, the lower-end of a previous range that touched up to £58 million. Investors sent the shares down by as much as a fifth.
Short-term trading is one thing. Management has blamed weaker demand for big ticket items like bikes for lower profit guidance. But it also raises questions over whether it will meet medium-term targets set out earlier this year, on time.
The group is betting on stronger trading during the second half of the year, helped by easing cost inflation and a stabilisation in currency translations. But the festive trading season carries more risk than usual for the group’s retail operations. True, it has been trying to tilt more towards needs-based motor services. Yet cycling, where sales declined 2.8 per cent in the first half of the year, still accounts for just over a fifth of group sales.
The shares trade at nine times forward earnings, towards the lower-end of the long running range. But another cut to consensus forecasts of a similar magnitude that greeted the latest warning, would push up that multiple to around 11.
Management is hoping a focus on services and commercial customers will drive pre-tax profits towards £90 million to £110 million over the medium-term.
Analysts at Investec read that as 2027, rather than 2026. But even to get there in four years’ time would require compound annual profit growth of almost 12 per cent. That seems like a stretch based upon historic form.
Spending this year will be at the lower end of a target range of £50 million and £60 million. That is just as well. The group recorded a free cash outflow of £19.2 million in the first half of the year, which is partly attributed to an increase in stock levels. The rise in inventory is centred on its autocentre business, which is admittedly in a stronger position. But still, a review is under way to make stock management more efficient.
Reports of an approach by Redde Northgate last month had lifted the shares. The emergence of a firm takeover offer looks like the best hope for Halfords rerating any time soon.
Advice: Avoid
Why: Medium-term targets might be at risk
