Royal Bank of Scotland Group (LSE: RBS) (NYSE: RBS.US) chief executive Ross McEwan couldn’t keep his good news under wraps any longer: this morning, RBS said it expects to report first-half pre-tax profits of £2.7bn, roughly double the bank’s pre-tax profits for the same period last year.
This is, obviously, good news for shareholders in the bank — but it isn’t quite what it seems.
Indeed, in my view, the big news wasn’t to do with profits at all — it was about assets.
Profits aren’t up
Reading further into today’s announcement from RBS, the first thing you might notice is that the bank’s profits haven’t really risen at all:
| H1 2014 | H1 2013 | |
| Total income (revenue) | £9,978m | £10,608m |
| Operating profit before impairment losses | £2,870m | £2,858m |
| Impairment losses | (£269m) | (£2,150m) |
| Operating profit | £2,601m | £708m |
| Pre-tax profit | £2,652m | £1,374m |
Source: RBS preliminary summary consolidated income statement H1 2014
The big difference is the massive reduction in impairment losses, or bad debts.
This is pretty impressive, and could be a big win for Mr McEwan, if it can be sustained: after more than five years, investors may be able to regain confidence in RBS’s balance sheet, and the value of its assets.
RBS shares have been trading at a substantial discount to their book value for a number of years, because investors were suspicious about the remaining level of bad debt in the business.
This morning, RBS reported a tangible book value of 376p per share — almost exactly the level to which RBS shares have risen this morning, signalling that investors are willing to trust the bank’s assets.
What about earnings per share?
In today’s announcement, Mr McEwan sounded a note of caution, warning investors that “we have had two good quarters, but no one should get ahead of themselves here – there are bumps in the road ahead”.
The bank still faces legal problems, and although the increase in pre-tax profits is good news, I’m not sure that it will really move the needle on current forecasts for RBS’s full-year results.
Current consensus forecasts suggest that RBS may report earnings of 23p per share this year.
My rough calculations suggest that even if the bank’s performance is maintained during the second half of the year, the upside to current consensus earnings forecasts is quite modest — perhaps 2-3p — which would still leave RBS trading on a 2014 forecast P/E of around 14.
Remember: there’s still no dividend, RBS is still 80% owned by the government, and the bank is no longer trading at a discount to book value, which changes the investment case for value investors.
