Are The Banks A Buy?

Published in Investing on 27 September 2012

Banks have destroyed huge amounts of shareholder value in the last five years. Are they now buys?

Stephen Hester, chief executive of Royal Bank of Scotland (LSE: RBS), grabbed business headlines this week. Mr Hester described RBS as coming to the end of phase one of its recovery. So, are RBS shares cheap today? Or would your money be better in one of the other shares in the sector?

I've grabbed the latest forecasts and fundamentals for HSBC (LSE: HSBA), Lloyds (LSE: LLOY), Barclays (LSE: BARC) and Royal Bank of Scotland.

CompanyPrice (p)Yield (historic)Yield (forward)P/E (historic)P/E (forward)Market cap (£m)
Barclays213.52.72.917.26.827,170
HSBC5784.34.610.110.5106,740
Lloyds Banking Group39.302.5N/A*18.827,410
Royal Bank of Scotland258.500N/A*12.815,960

* previously loss making

1) Barclays

Barclays is the financial organisation most frequently associated with the LIBOR scandal. The conduct of a number of its employees did enormous damage to the bank's reputation worldwide. Barclays' failings forced both the company's chief executive and chairman to resign. At the very worst, shares in the bank fell to 150p.

Unlike its state-sponsored peers, Barclays is profit-making and dividend-paying. At the halfway stage, Barclays reported a statutory profit of £759m.

Barclays declares and pays dividends quarterly. With its interim results in September, Barclays announced a 1p dividend. Dividends for the first half of 2012 equalled 2p, unchanged from the previous year.

For the full year, Barclays is expected to pay a total of 6.8p in dividends. At today's price, that equates to a 3.2% yield. The analyst consensus is for full year earnings per share (eps) of 28.8p.

Both of these figures are expected to increase significantly in 2013. If Barclays delivers on this forecast growth, investors could see significant price appreciation.

2) HSBC

Of the four banks featured, HSBC survived the financial crisis best. Although the shareholder dividend was cut for 2008, payouts continued and started to increase again in 2010.

HSBC has more exposure in the Far East than the rest. The result is that earnings now are close to the same level enjoyed before the crisis broke.

Consensus is for earnings to fall slightly for 2012 before returning to growth in 2013. The shareholder dividend is expected to increase ahead of inflation, pushing the yield to around 5%.

Trading at just 10.5 times 2012 forecast earnings, HSBC is significantly cheaper than the average FTSE 100 (UKX) share. However, of the four I believe its shares would advance the least in a broader recovery. Simply put, the market doesn't see much risk in HSBC shares. If economic gloom lifts, investor expectations at HSBC would not change massively. While HSBC may be a dependable long-term hold, it is not a great recovery opportunity.

3) Lloyds Banking Group

Shares in Lloyds have already enjoyed a significant rise. Lloyds is up nearly 30% in the last three months. In that time, Barclays shares have risen 11% and RBS by 12.5%. HSBC is up just 3.6% in the last quarter.

How has Lloyds outpaced its rivals so significantly? My guess is that the market believes Lloyds is less exposed to the eurozone and that the bank be returning to profit sooner than previously expected.

The half-year results from Lloyds reported net tangible assets per share of 57.4p. This is 46% ahead of today's share price. Lloyds is forecast to make a profit both this year and next. If it can deliver on these expectations, I expect that discount to close.

The PPI scandal has damaged Lloyds. Shareholders will be hoping the bank can escape any serious punishment over LIBOR. If it can move beyond these two issues, then the upside potential is obvious.

4) Royal Bank of Scotland

Royal Bank of Scotland's progress has been remarkable. At the worst point of the financial crisis, RBS' loan:deposit ratio was 1.54:1. Today, chief executive Stephen Hester says it is "more or less" 1:1. RBS was nearly killed in the credit crunch by a lack of liquidity. Now, Mr Hester reports that the company has "an embarassment of liquidity". Today, RBS' short-term wholesale funding -- money it borrows from other banks, etc -- is far smaller than the banks own liquidity reserves. Previously, this relationship was the inverse.

Currently, RBS is the least attractive from an income perspective. RBS management hopes that by the end of 2013, the company's ability to pay future dividends will be clearer.

Meanwhile, shareholders can comfort themselves with the fact that the shares are trading at a large discount to book value. At the half-year stage, RBS reported a net asset value per share of 489p.

RBS is probably the bank most highly geared toward a turnaround.

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Further investment opportunities:

> David owns shares in Lloyds Banking Group and RBS, but no other shares mentioned in this article.

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Comments

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BigJC1 27 Sep 2012 , 1:14pm

The difficulty is understanding the underlying core profits, provisions and asset write downs. Most of the banks have driven through massive cost saving programmes, retained a great deal of their customer base and infrastructure, written down vast amounts of assets/loans and have access to low cost government funds.

The turning point for both Lloyds and RBS will be the return to dividend which in turn is likely to see the gradual reduction of state ownership.

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