Shares in Metro Bank (LSE: MTRO), one of the UK’s leading challenger banks, have fallen around 90% from their all-time high over the past 18 months.
Following this decline, the stock looks attractive as a value investment. However, while the shares might seem cheap at first glance, it is essential to remember why investors have turned their backs on the business in the first place.
Struggling business
At the beginning of 2018, Metro was flying high. The bank was meeting or exceeding its growth objectives, and it looked as if the group’s growth was unstoppable.
For the first quarter of 2018, Metro reported a 41% year-on-year increase in customer deposits, lending growth of 69% and an underlying profit before tax of £10m for the quarter.
The firm’s growth story began to unravel in the first half of 2018. Soon after commenting that the group had plenty of capital to fulfil its expansion plans, management announced a £9m placing of new shares representing approximately 10% of the company’s issued share capital to bolster its balance sheet at the end of July.
Then in the third quarter, growth started to slow. Deposit growth halved in Q3 2018.
Metro’s problems only got worse in the first half of 2019. The company revealed that it had miscalculated the strength of its balance sheet and was forced to ask shareholders for £350m of extra capital in May. The revelation shocked investors and customers.
A better buy
Since May, Metro has been working hard to try to restore investor and customer confidence. Nevertheless, it’s clear to me that this bank will never be able to rebuild the sort of reputation it had at the beginning of 2018.
And with this being the case, I think it would be wise for investors to avoid the challenger bank altogether and invest in Royal Bank of Scotland (LSE: RBS) instead.
You see, while Metro looks cheap, trading at a price-to-tangible-book-value of just 0.3, RBS is just as undervalued. Shares in the bank are currently dealing at a price-to-tangible-book-value of 0.6 and RBS has other attractive qualities, such as dividends.
For 2019, City analysts believe that the bank will return a total of 24p per share, giving a dividend yield of 12.2% on the current price. Analysts are expecting a total dividend of 16.7p for 2020, a potential dividend yield of 8.6%.
Rising profits
What’s more, unlike Metro, RBS is highly profitable. Analysts believe the bank will report a net income of £3.4bn for 2019. That puts the stock on a forward P/E of 7.6.
Of course, RBS does also have its own problems. Brexit uncertainty, regular IT problems and a low return on equity are all issues for the bank, but compared to Metro, it looks to me to be the much better bet. The group’s balance sheet is much stronger, it is much more profitable, and RBS is returning capital to shareholders.
Overall, if you are looking for an undervalued banking stock to add to your portfolio today, I reckon RBS would be a better buy than Metro. Even though Metro looks deeply undervalued, it’s questionable if the bank can ever return to its former glory.
