Thursday, 29 October 2015

Barclays - higher costs and revised guidance but still clear potential

In my last write-up on Barclays I noted:

'Barclays is not out of the woods at all but with a combination of growth scope at Barclaycard and its African operations, simplification assisting the utility-like retail banking division and focus assisting the investment bank there are angles still for shareholders.  Barclays shares may have generally been grinding up this year but to remain hopeful of a grind past 300p remains a reasonable view'

I could almost make a similar observation today...albeit that volatile markets and a few other matters we will come onto have nobbled the shares slightly which - as I write - are now trading at the time of writing around the 240p level. So much for grinding past 300p...

The reasonably solid aspect of the numbers centred around the core division where profitability pushed up for all divisions (although only on a constant currency basis for the Africa Banking unit).  At a headline level this growth was only low single digit but this reflected higher structural reform implementation at the head office level a theme - unfortunately - we will return to later.  

Of course Barclays cannot only be a Core business...and trends at the Non Core business at least showed falling average allocated equity...but still clear losses.  Management confirmed on the conference call that especially in 2017 costs will fall but a material improvement in 2016 seems unlikely to me. 

Put the two together and the latter remains a clear drag which is a shame as my hopes for a 300p+ share price is based on a still rising tangible NAV to 289p aligned with a double digit ROTE.  Adjust however for the full non-core cost and you end up with a theoretical value today of nearer 200p (289p * 0.67 derived from the 6.7% RoTE for the overall group).  

Of course this is unfair as the non-core business is necessarily relatively static / attempting to be wound down whilst contributors to the Core businesses have dynamic growth potential etc.  However what it does show is that guidance becomes all important.  

And this brings us to the company's updated guidance.  Remember those higher structural reform costs?  Well they are making another appearance and it impacts that important Core return on equity hope.  Hitting 11% (versus 9.5% in the first nine months of 2015) still implies a positive impact on valuation for the whole group but - as noted above - such accretion is already factored into a 240p share price let along a nearer 300p one.  

I still believe that Barclays has the right set of assets to push towards and beyond that 300p share price level.  It also has a new CEO starting on 1 December and still some uncertainty as to whether the role of the investment bank will be emphasised or de-emphasised.  Given investment banking's more volatile stream of returns (on the conference call it was suggested by an analyst that possibly the investment bank could be negative return on equity during Q415) I would prefer the latter.  My instinct is that this will be the conclusion of the Barclays board too. 

Pulling it all together I like the 220-240p support area for Barclays shares as this share price broadly factors only in accomplishment of the 2016 revised targets plan.  Further non-core compression in 2017 plus general progress in showing the sum-of-the-parts Core value should make 2017 even more interesting.  Given the stock market is a discounting machine this implies 2016 should be a better year for Barclays shares than 2015 has been so far assuming the global economy doesn't fall off a cliff of course. 

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