Barclays: Normalized Forward Dividend Yield of 4%
The negative sentiment around Barclays, and cyclical component of the downturn in investment banking, creates a buy opportunity. It is not without risk given the potential legal/regulatory costs associated with alleged manipulation of the libor/currency markets, but investors are offered a large margin of safety; at 253p, Barclays is trading at a 10% discount to current tangible book value (“TBV”) which is likely to increase through 2014.
– Our estimate for end-2014 TBV/share is over 300p based on in-line EPS of 25p and a 40% dividend payout ratio translating to 10p/share (and 4% yield on the current share price). We expect the increase in the dividend from the current 6.5p/share to be announced at the 2014 AGM in April. Both dividend and TBV are at risk to legal/regulatory costs but these would need to reach GBP5bn for there to be both no dividend raise and for TBV to decline.
We understand investor concerns on cost, particularly given the 10% increase in the 2013 bonus pool, but expect management to meet its expense target (of GBP16.8bn in 2015 down GBP1.4bn from 2013) through re-engineering. Meantime, Barclays cannot afford to lose good people in the investment bank, and we are concerned the compensation debate may be overly influenced by optics over economics (see Exhibit). Assuming management can pay competitively and notwithstanding increased capital intensity, the investment bank (absorbing ~40% of firm-wide equity) is an attractive business with a normalized ROE in the low-to-mid teens:
– Barclays is gaining share in equity capital markets and has a top-ranked FICC flow-derivatives business in both Western Europe and North America. In addition, we are confident CFO Tushar Morzaria (as former CFO of the Corporate and Investment Bank at JPM) will reduce the comp-to-income towards management’s target of the mid-30s from the current 43%.
– While Barclay’s target for a CET1 ratio of 11.5-12% is currently higher than targets for competitors (e.g. “above 10%” at HSBC and 10-10.5% at JPM), the gap will likely close. HSBC, for example, has acknowledged it could get guided to a higher point, and we expect the Fed’s “advanced approach” and CCAR testing to raise capital requirements for US banks. Ultimately, we do not expect UK regulators to impose disadvantaged end-state capital requirements on Barclays relative to large, global competitors.
– If we are wrong about a level playing field, Barclays will shrink or exit businesses rather than erode book value. While there will be exit costs, these are more than offset by businesses (see below) which generate returns materially above the cost of capital and so are worth more than book. This makes firm-wide tangible book value of 283p/share (albeit subject to currency swings) a very conservative measure of floor valuation.
Looking beyond the investment bank, one-quarter of Barclay’s GBP52bn of common equity is absorbed by structurally attractive businesses including the UK retail branch bank (~15% of equity) with returns in the low-to-mid teens and Barclaycard (~10% of equity) with a high-teens return. Our concern is not with the investment bank but with the ~30% of Barclays capital deployed in under-managed businesses including the corporate bank (~15% equity and ROE<5%) and three equally-sized businesses (retail banking in Europe and Africa, and wealth management) which, between them, absorb ~12% of equity and, largely because of Europe, generated a 2013 loss of GBP1bn. We assume fixing these businesses is a CEO-level priority.