|Shares Out. (in M):||17,060||P/E||10.3||8.6|
|Market Cap (in $M):||51,500||P/FCF||NA||NA|
|Net Debt (in $M):||0||EBIT||0||0|
Barclays plc (BARC) is a large-cap global bank that trades at a material discount to tangible book value (0.8x). Like many large European banks, BARC has been restructuring and shrinking since the financial crisis. I believe BARC is now at the end of this restructuring process and has a credible plan to earn double-digit returns on tangible equity (ROTE). In October 2017, BARC outlined targets of >9% ROTE by 2019 and >10% ROTE by 2020. Consensus is skeptical and is only forecasting a ~8.5% ROTE by 2020. However, if BARC ends up achieving a 10% ROTE in 2020 this would result in ~29p of EPS. If BARC can trade at 11x P/E and 1.1x tangible book value, this would mean 45-50% upside for the stock.
After selling off non-core businesses over the last several years, BARC now operates three main businesses: Corporate and Investment Bank (CIB), UK retail/commercial bank (BUK) and international consumer, cards and payments (CCP). After allocating Head Office capital and losses, both BUK and CCP generate 12-13% ROTEs. CIB (after Head Office allocations) only generated a ~4% ROTE in 2017. Since ~1/2 of BARC’s capital is in CIB, an improvement in CIB ROTE is a key driver of getting group ROTE to >10%.
BARC’s CIB has languished after years of neglect but appears to have new vigor after Jes Staley (former head of JPM’s investment bank) took over as CEO in December 2015. Note that prior to Staley, the CEO of BARC was from the credit card business, so I believe CIB was formerly held in relatively low regard by BARC senior management and thus suffered from underinvestment. Since Staley has taken over as CEO of BARC, he has installed a new CIB head (Tim Throsby from JPM) and replaced three of four heads on the trading desks. These CIB management changes occurred in 2017, so 2018 is the first year that the new CIB team is fully in place. In late 2017, BARC also publicly talked about committing more of its balance sheet to the trading businesses, which I believe have been capital constrained due to BARC capital concerns. Because 2017 was a transitional year for CIB management and had a weak macro backdrop (lack of volatility in market), BARC’s trading revenues were down -15% (FICC trading -18% and equities trading -9%). I believe the poor 2017 performance, new teams put in place, bigger balance sheet commitment and higher market volatility set up BARC to show improvement in trading revenues in 2018. In fact, Q4 2017 already saw BARC regain some share in FICC trading.
The BARC ROTE improvement plan isn’t only a bet on CIB revenues. I believe roughly half of the planned ROTE improvement can be attributed to “self-help” measures. Part of this comes from cost reductions, driven by reduced spending on regulatory and compliance. BARC has guided to £13.6-13.9bn of expenses in 2019e, down from £14.2bn in 2017. BARC also has the opportunity to refinance high-cost funding that was issued during the financial crisis. For example, there is a £3bn 14% junior subordinated hybrid that is callable June 2019 – this one refinance alone could save ~£300m per year which could add ~0.5% to BARC’s ROTE.
There are two ROTE tailwinds that weren’t included when BARC management gave its >10% 2020 ROTE target back in October 2017. First, the ROTE targets were developed assuming a group tax rate in low-30s, but as a result of US tax reform BARC is now projecting a mid-20s tax rate. Second, BARC management didn’t assume interest rate increases during the plan, but UK interest rates have risen in the last 6 months. In their Q4 2017 earnings presentation (pg. 36), BARC estimated that a 100bps increase in interest rates would result in £200-450m more net interest income (NII) in year one, building to £850-1,150m of additional NII by year 3 (benefit is lagged as securities are reinvested at higher yields as they mature). Here is the rough math on how higher NII translates to ROTE: every £200m of NII is £150m after tax, so ~0.3% on £48bn of tangible equity.
A persistent concern has been BARC’s capital levels as bears have made the argument that there isn’t enough capital to deal with legal/regulatory fines and ring-fencing of US and UK subsidiaries. However, management’s February announcement that it intends to double the dividend in 2018 (3.0% yield on current price) and is looking to buy back stock (I believe 2019 is more likely than 2018) is a strong signal of confidence in the capital position of BARC. I do not think BARC management would have been able make such a strong public statement on capital returns without blessing from its regulator. A further positive development was the late-March announcement of a lower-than expected ($2bn) settlement with the US DOJ over housing bubble era RMBS issuance. I believe BARC’s capital levels are at a comfortable level. BARC had a 13.3% CET1 as of 12/31/17, which will dip under 13% with payment of the $2bn DOJ settlement but rebuild relatively quickly as BARC should generate ~100bps of capital this year from earnings (before shareholder returns).
Finally, an activist investor named Edward Bramson recently took a large stake in BARC. While I don’t have any personal knowledge of his agenda, press reports indicate that Bramson wants BARC to reduce the size of its trading operations in order to free up capital. https://www.telegraph.co.uk/business/2018/04/14/activist-investor-ed-bramson-steps-campaign-force-barclays-shake/. This would run counter to Staley’s current plans to invest more into the trading operations. Bramson has an impressive track record in past activist campaigns with his 5 successful investments averaging returns of >100% and having only one unsuccessful activist investment. (See prospectus for his Sherborne investment vehicle for more details: http://www.sherborneinvestorsguernseyc.com/investors/introduction.php). Since BARC is a much bigger company than Bramson’s past activist investments, I don’t know if his past successes will translate to success in this BARC investment. However, the presence of a credible activist investor should increase the pressure on management to hit their promised ROTE targets, particularly when the activist is suggesting a change of course on the CIB strategy.
Progress towards >10% ROTE target by 2020
|Entry||04/23/2018 03:14 PM|
Thanks for the idea Kevin, few questions:
1) I know your write-up includes some details but can you provide a "quantitative" bridge (driver with contribution) of how the company gets from 5.6% Adj.ROTE in 2017 to 9% in 2019 and 10% in 2020?
2) CIB - where do the new heads come from and do you have a sense of their track records in building/restructuring businesses? how much additional capital is being allocated to the business and how much confidence do you have that the incremental capital will generate an "attractive" ROTE? I understand that vol is back but is that sufficient or is there risk some "vig" gets competed away?
3) What are biggest risks here over the next 18-24 months besides a recession? i understand the company appears well capitalized at 13.3% CET1 but do you believe the balance sheet is adequately provisioned for a potential spike in defaults?
|Subject||Re: Few questions|
|Entry||04/24/2018 06:33 PM|
1) For an ROTE bridge, I would take a look at the BA-ML note dated 11/20/17 for a detailed analysis. In my opinion, here are some of the "lower hanging fruit": reduction of non-core losses in 2017 ~1%, 2019 cost target vs 2017 costs ~1%, benefit of refinancing high-cost funding ~0.5%, and lower tax rate ~0.5%. These add up to a ~3% ROTE benefit from 5.6% starting point, or ~8.5%. To get to from 8.5% to 10% ROTE one has to believe in some top-line recovery. If you assume 80% incremental margins and 25% tax rate, you need ~GBP 1.2bn of additional revenues to drive a 1.5% ROTE improvement. This isn't a huge number on a 2017 revenue base of GBP 21.1bn (over two years). I don't have an exact path on how revenues will evolve, but here are some rough numbers to use for some sensitivites: 2017 trading revenues were GBP 4.5bn, and these were GBP 5.3bn in 2016. Even with GBP/USD headwind, but I don't think it's crazy to think this BARC could get back GBP 500m + of revenues in next 2 years (esp. as DB continues to struggle). The non-trading businesses are also growing and 2% growth for 2 years on GBP 16.6bn would results in GBP 600-700m of revenues. One can also plug in a guesstimate for benefit of higher UK rates based on the sensitivities BARC provided.
2) Here is a good article on the backgrounds of the new markets heads: https://www.euromoney.com/article/b15c60blfh4skl/sideways-staley-bets-the-farm-on-the-fab-four. I obviously can't say with absolute confidence that these management changes will create an instant turnaround because this is a competitive business (as you mentioned). However, it seems like the markets business lacked leadership for a long time so its a pretty low bar they are starting from. If you read BARC's Q3 2017 conference call transcript, there is some discussion of how they are re-allocating risk-weighted-assets within the CIB to higher returning businesses. I will admit I don't have great granularity on incremental ROEs on the businesses they are growing vs shrinking, but I do think the mangement team is taking a fresh look and approaching the CIB in a sensible way.
3) BARC has a large investment banking business, so the biggest risk is recession or a big correction in the markets. BARC has a large UK retail/commercial bank, so if Brexit takes a nasty turn this would obviously be bad (but UK economy seems to be holding up pretty well and I believe Brexit looks like it's on a manageable transition path). BARC has inherently high beta to the markets, so this is a key risk. As for your questions on credit, I do not believe there are any major concerns with credit at present. Annualized provision expense were 57bps in 2017 and 53bps in 2016. They ended 2017 with ~1.5% non-performing loans and loan loss provisions of 1.1% of loans (78% coverage of NPLs).
|Subject||Re: Re: Few questions|
|Entry||04/25/2018 09:51 AM|
Thanks for the reply Kevin. I don't have access to BAML research so any chance you could cut/paste the relevant analysis from the report?
|Subject||Re: Re: Re: Few questions|
|Entry||04/25/2018 03:08 PM|
Below is the BA-ML chart I was referring to. This was published Nov 2017, so a few things have changed including 1) starting 2017 ROTE being higher (5.6% vs 4.5%), 2) US tax reform passed, and 3) higher interest rate environment. Thus, I think the GBP 2.7bn of needed revenue growth in his chart is now much lower (my estimate is more like GBP 1.2bn).
For some more details on the turnaround plan, I would point you towards BARC's Q3 17 results presentation. And more specific to what BARC management team is doing to reposition CIB trading business, take a look at the presentation that Tim Throsby made at BA-ML conference in Sept 2017.
|Subject||Re: Re: Re: Re: Few questions and Quarter|
|Entry||04/26/2018 11:50 AM|
Separately any thoughts on the quarter? Seems like the market is unenthused. Also, (1) the 9-10% decline in TNAV, and (2) negative attribution from Head Office, specifically the legacy funding (neg 90/q) and hedge accounting (neg 100-200/yr) - do you think these items impact the '19/'20 ROTE guidance?
|Subject||Litigation and conduct expense|
|Entry||04/26/2018 03:11 PM|
Kevin - in order to highlight the performance of the underlying operations, mgmt refers to numbers on an adjusted basis, i.e. excluding litigation and conduct, which obviously makes sense. The reality, however, is that over the last ~4 years, Barclays has spent ~GBP12bn on litigation and conduct...a pretty large and frequent liability for a 'non-recurring' expense. How are you thinking about this in terms of future costs and in your valuation? Thanks.
|Subject||Re: Re: Re: Re: Re: Few questions and Quarter|
|Entry||05/01/2018 08:14 PM|
I don't believe the Q1 results change their ability to hit ROTE targets in 2019 and 2020.
The decline in TNAV was worse than expected, but this is due to IFRS-9, RBMS settlement and PPI charge which weren't fully reflected in expectations. The first two of these should have been known but PPI came earlier than expected (more on this on my next reply). The bright side is that taking all these hits in Q1 clears the decks - I don't believe there will be big "one-off" hits to TNAV going forward. Thus, I expect TNAV to build pretty quickly - I believe TNAV will at 20-25p of annual EPS less 6.5p dividend so will get to around ~270p by end of 2019.
As for the legacy funding and hedge accounting in Head Office, this was "worse than expected" but really just the result of BARC pulling these items out of divisions and sticking them into Head Office. The silver lining here is that we now have these headwinds quantified and have better visibility into this component of ROTE improvement as these drages tail off in 2019 (e.g. 90m/Q of legacy funding should go away in mid-2019 when 14% RCIs are called).
Let me know if you think I am being too optimistic here, would love to hear a more negative take if you have one.
|Subject||Re: Litigation and conduct expense|
|Entry||05/01/2018 08:23 PM|
Litigation and conduct has been a huge drag for BARC, but I believe this is largely in the rear-view mirror. The biggest portion of this is PPI which has cost BARC a cumulative 9.5bn in provisions. However, the last date for claims has been set by UK government (Aug 2019), so we can now have greater confidence in this tailing off. As mentioned earlier, BARC took a 400m PPI provision in Q1 - I thought they'd have to top off this provision some time before Aug 2019, but I didn't expect it to happen in Q1. At this point there may be another small PPI top-up if there is a rush to file claims before the Aug 2019 deadline, but I think PPI is largely behind us. The other large litigation and conduct overhang was US RMBS, which was settled in Q1. Therefore, I think going forward (2019 and beyond) litigation and conduct will be a small drag (maybe 100m/yr guesstimate) as there are always unpredictible things that pop up for a large bank, but not the billions of pounds that it has been historically.