Are Barclays Shares Too Cheap?

What’s in a price? Barclays at 150p! The valuation ignores the significantly better prospects that arguably lie ahead. A bargain basement offer?

If the UK economy is still suffering from the gargantuan world banking collapse eight years after implosion began, then so too are the banks. Barclays’ share price has been unable to resist the downward pull of gravity. So what is one to make of this equity at this stage?

The first thing to observe is that the share price pattern still etches a downward trend that has been in existence since the middle of last year. In the months prior to mid 2015 the share price had been recovering nicely up towards the 300p level, which it had several times got close to in 2013. In mid 2015 it failed to reach that destination indicated by the trend, instead turning away and heading downwards. The last twelve months have proved an appalling period for banks generally. Barclays’ shares, year on year, are down 41%. It did much worse than the FTSE 100 Index, which, although weak, fell only 10.6%.

Summing things up, banks in general were a geared play on the uncertain world of the last twelve months; they also had their own sectoral problems including fines and litigation charges and costs for what seemed to be a catalogue of never ending misdeeds. Barclays, seems to have been a brand leader in that department. Even now the papers carry stories related to the investigation into the bank’s equity raising in the Gulf during the initial banking crisis, to keep it from seeking assistance from the UK Treasury. There is also the judicial action taken against senior Barclays staff over the fixing of the LIBOR market. Not to mention the ironic uncertainty about the future role of its investment banking operation based, as it is, in part on Lehman’s business (an acquisition that at the time looked like a spectacular coup by a British bank). The ghost of Lehman still inhabits Barclays’ investment banking corridors.

It has all been a bit like a Jacobean revenge tragedy with nobody seemingly up to much good and bodies everywhere, including that of the late Chief Executive, “Saint” Antony Jenkins who seemed a throwback to the bank’s Quaker founders. He was thrown from the ramparts last summer in favour of “Jes” Staley, the former Wall Street man and CEO of J.P. Morgan, who is charged with executing the bank’s strategy of “accelerating” the return to better shareholder returns. His arrival has done nothing to arrest the share price downtrend, partly no doubt, because it introduced a new note of uncertainty about the role of Barclays’ riskier investment banking activities. Earlier indications were that the investment banking side would be scaled back.

And then there are the costs associated with restructuring banks to reduce their exposure to risk generally as well as the need to increase capital, at the prodding of the knife point of a regulatory stiletto. Now, pips are beginning to squeak and worms beginning to turn. That must include a further improvement in the bank’s capital base if it wants to chase the riskier but higher margin business.

Mr Staley has overseen the sale of Barclays’ African commercial banking business. But even that divestment has so far failed to raise and improve the market’s animal spirits in favour of the new regime. Basically, the evidence is that Barclays’ share price weakness over the last twelve months seems largely due to the fact that the banking sector as a whole has, with one partial exception, performed dramatically poorly over a year. The exception is of course Lloyds, where the share price has dropped a “mere” 18%. HSBC, RBS and Barclays are closely bunched at around a 40% decline.

The truth, insofar as you can discover it about banking, is that things have not yet settled down; the banking volcano still hisses steam and gas. In the UK there is a perception that the Chancellor is anxious to reduce the regulatory pressure on banks; but in the US there is still reformist talk. There the debate is about the desirability of splitting riskier investment banks from their “less risky” deposit taking and lending sides. (I put “less risky” in inverted commas because banks historically, even without investment banking, could be pretty risky from time to time.)

There is also a wide range of suggestions amongst academics and other thinkers as to what constitutes the safest level of capital to sustain banks through another major crisis. The banks obviously promote a lower figure for commercial purposes, whilst some others (outside banks) propose levels of capital above those now higher levels currently in force. Banks are self evidently still large and still pose, in the minds of some bank watchers, the nightmarish fear that they remain “too big to fail.” Will the funereal “living wills”, the ring fencing off of the deposit taking lending and traditional lending part of banks along with regulatory oversight prove enough be enough to save the poor bloody taxpayer?

Clearly, all this is a matter of endless speculation and the diversity of value judgements. In the end it has to be settled politically. My guess is that given the way of the world, as we know it to be, we are probably close to a political balance on the subject. Governments are anxious to get the banks making a contribution to stimulating near-term growth for obvious political reasons and considerations. Basel Treaty capital ratios have been raised, and in the UK, there is a regime of regulatory stress testing. These may not be to the satisfaction of all contributors to the great and continuing bank safety debate, but to judge from the UK government’s political body language they are, on pragmatic grounds, good enough.

Back to Barclays in particular, the bank has travelled some distance in increasing its capital ratio along with the banking industry generally. It has rather impertinently expressed dissatisfaction with distancing the deposit taking “ring fenced” board. It continues to restructure its business to boost cash and capital resources to support its core activities. What it badly needs, as does the UK banking industry generally, is a release from penalties and fines. It is a tribute the fundamental underlying strength of the banking business that it has been able to find the billions to pay these and still increase bank capital. Comments from the House of Commons Select Committee talk of total industrial fines and related costs of 60 billion plus with PPI restitution adding the equivalent of 2% to UK annual GDP. Once that ceases or significantly diminishes, as looks likely, those sums will boost the bottom line of banks, to their advantage.

So what does the market, in the shape of the consensus estimates of future prospects for Barclays, think likely at this stage? First, a steadying of top line revenue. Five years ago at Barclays, that stood at £33 billion. Last year that had fallen to £23 billion. It is now estimated to stay at that level this year and next.

Earnings per share for this year to December 31^st 2016 are currently estimated to remain close to last year’s 16.6p but to jump by more than a third next year. If that is achieved, we are talking about Barclays shares achieving earnings per share of an estimated 22.8p, valuing them, at the current price, at less than seven times those forecast earnings per share. The forecast estimated earnings projection is accompanied by an improvement in dividends from an estimated 3.75p for this year to 4.2p for next year, which places Barclays equity on a forecast dividend yield of 2.8%, which is covered 5.4 times by the related forecast earnings, giving plenty of leeway to put money into the balance sheet first, followed in due course by a handsomely progressive dividend payout in future years.

The shares on that basis look highly attractive. The market is understandably nervous and disenchanted with banks but that is arguably part of their attraction now as a long-term dividend paying investment. Mr Staley evidently has what it takes to make such a return. The share price at 150p is not only down 45% on a five-year basis but is also standing at what looks like a five year trading range. The shares would appear to be full of disappointment and very little hope. Consequently, despite the current downward share price chart pattern, the shares seem to be offering undiscounted better prospects.