When I think of banking company Royal Bank of Scotland Group (LSE: RBS) (NYSE: RBS.US), two factors jump out at me as the firm’s greatest weaknesses and top the list of what makes the company less attractive as an investment proposition.
1) Poor cash performance
Royal Bank of Scotland is engaged in a massive restructuring programme and all the write-downs, divestments and de-gearing involved makes it hard to see the underlying performance of the business.
When in doubt, one thing we can do is follow the cash. So let’s look at RBS’s record on a number of cash indicators:
| Year to December | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|
| Net cash from operations (£m) | (992) | 19,291 | 3,325 | (45,113) | (30,631) |
| Net cash from investing (£m) | 54 | 3,351 | 14 | 27,175 | 21,183 |
| Net increase/decrease in cash (£m) | 9,261 | 8,344 | 125 | (19,814) | (11,664) |
Operations have called heavily on cash over the last couple of years with investment gains offsetting some of the pain. However, the table shows that investment gains are volatile, so to make Royal Bank of Scotland’s business sustainable, operations need to generate cash consistently going forward.
2014 could be a better year for RBS on cash generation, but there’s still a big gap to close before the firm achieves cash break-even. Cash flow is worth keeping an eye on if you are invested here.
2) Shrinking assets
As RBS struggles to free itself from the shackles of its legacy business blunders, the balance sheet is shrinking. Whichever way you look at it, Royal Bank of Scotland has a business that is getting smaller and that makes it hard to judge when the share price is reflecting a fair value for the company. Look at the record on net assets, for example:
| Year to December | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|
| Net assets (£m) | 94,631 | 76,851 | 76,053 | 70,448 | 59,215 |
How much further must assets shrink before RBS finds a steady equilibrium with its operations upon which it can build future growth? It’s hard to know, and that in itself seems sufficient justification for today’s 305p-share price to discount tangible net asset value by around 16%.
What now?
Banks like Royal Bank of Scotland are less attractive than they were a few years ago, around 2009. I think there’s still mileage in investing in RBS, but banks can be such complex beasts to analyse that it’s hard to ensure that we are buying good value.
