I seem utterly incapable of talking about banking shares without mentioning cyclicality. Do I need psychiatric help? Maybe, but one thing is certain, holding banking shares now is enough to give any investor the spooks.
Growing, growing, gone
Take Asia-focused Standard Chartered (LSE: STAN), for example, which oozes growth potential, and has done for a long time. Last year, the firm earned about 82% of its operating profit from Asia and 10% from Africa, two up-and-coming markets that seem likely to expand in the years ahead — what better way to play emerging markets than with a bank, we may ask.
The trouble is that Standard Chartered’s shares fell from a post-credit-crunch high around 1950p achieved during 2010 to 951p today. That’s an investing disaster for anyone holding on for the last four years, and one that apparently snatches defeat from the jaws of victory, after all, the firm’s financial record suggests trading improved over the period:
|
Year to December |
2009 |
2010 |
2011 |
2012 |
2013 |
|
Operating profit ($m) |
5,130 |
6,080 |
6,701 |
8,061 |
8,584 |
|
Net cash from operations ($m) |
(4,754) |
(16,635) |
18,370 |
17,863 |
9,305 |
What on earth is going on, then?
Cyclicality — pass the pills, nurse!
Stock markets allow for cyclicality, and there’s no sector more cyclical than that of the financials. Sooner or later, thinks the market, Standard Chartered’s and other financial companies’ profit and cash flow progress will reverse as general economic conditions deteriorate again. So, improving trading doesn’t impress, and valuations reduce — as profits rise, P/E ratings tend to fall.
The market knows that every improvement in trading moves us closer to peak profits, which precede the next cyclical plunge in earnings. The forward-looking market doesn’t want to be caught out, so it keeps valuations down. Furthermore, if there’s the slightest whiff of a decline in economic activity, which could seriously affect the profits of cyclical firms, share prices will plunge. That’s what happened over the last couple of years with Standard Chartered as news emerged of weakness in its markets.
So where are we now?
In a recent update, Standard Chartered’s chief executive said that trading conditions are subdued. The firm is reprioritising investments, exiting non-core businesses, de-risking certain portfolios and reallocating capital. There’s a focus on costs, and the company aims to save more than US$400 million in productivity improvements during 2015. The actions the firm plans will likely affect near- term performance, but they are crucial to getting Standard Chartered back on a trajectory of sustainable, profitable growth, he reckons.
Right now, Standard Chartered looks more like a firm struggling to turn its fortunes around than a company intent on world domination through growth. That’s the unfortunate truth, but we need look no further than the affects of cyclicality to identify the culprit.
The shares trade on a forward P/E rating just over eight for 2015 and City analysts predict a 10% earnings’ rebound that year. Meanwhile, there’s a 5.6% dividend yield with the payout covered more than twice by adjusted forward earnings.
The share price seems to have plunged recently, so is it time to buy now? I don’t know. The cyclicals are so hard to judge, and that’s the problem. Do we need a bank in our portfolios at all, particularly when there are firms with strong trading franchises that can really drive wealth creation if we buy the shares at sensible prices?
