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Barclays PLC Shareholders May Not Survive The Bank’s Rally

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The fall and rise of Barclays (LSE: BARC) (NYSE: BCS.US) has been spectacular over the last five years, during which time the stock has traded in the 130p-350p range. Its performance for the period reads -9%, excluding dividends. State-owned banks such as Lloyds and Royal Bank of Scotland have done better than that. 

The Rally

At 263p, the shares currently change hands some 5% to 10% above their five-year median, but volumes are below average. This may mean very little to value investors, who may focus on the bank’s declining leverage and a price to tangible book value below 0.9 times, but what it tells me is that Barclays is being targeted by opportunistic traders. 

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The bank’s stock is fast approaching its 52-week high of 267.5p and may continue to rally if bullish estimates from analysts are met, true. But there’s also a chance that the stock will soon fall like a stone. In this context, I don’t expect positive news on 3 March, when the bank’s annual results are due. 

According to market estimates, Barclays profits will steadily rise to almost £5bn in 2016, for a three-year compound annual growth rate of 107%. During the period, revenue will likely drop by more than £1bn to £27bn, however, with a 2016 dividend yield that will almost double to 4.75%. 

It doesn’t look right. 

In this environment, banks’ revenues are not going to grow much, so rising operating profits must come from cost-cutting measures. But slashing costs can jeopardise the value of a bank’s retail offering, even that of a bank like Barclays. This is not ideal at time when profits from investment banking are under pressure. 

Profits & Returns

Enter recent trends for profits and returns by business units.

Return on equity (ROE) and return on average tangible equity (RTE) are up across all divisions, excluding investment banking (IB), and this is not ideal for Barclays. The IB unit contributes less to total earnings these days, but still absorbs a huge amount of capital. 

The performance of the IB unit, as gauged by RTE, was down to 5.1% year on year from 11.8% in the nine months ended 30 September 2014, with pre-tax profit down by £814m to £1.3bn (26% of the group’s total) over the period. 

The average allocated equity to IB stood at £15.3bn, which compares with £17.3bn for the more stable Personal and Corporate Banking (PCB) business, but PCB reported 18% growth in pre-tax profit, which was up to £2.2bn in the nine months ended 30 September. The PCB unit has an RTE of 16.7%, and ranks just behind Barclaycard, which generates less actual profit, at 23%.

Yearly results will likely show similar trends, in my view. So, in order to hit bullish estimates for earnings, Barclays should grow its investment banking unit, but in doing so it’d have to allocate too much capital to a more volatile division, where surging profits would likely be challenged by regulators. In fact, Barclays is cutting thousands of jobs in IB — as IB shrinks, however, earnings forecasts will become more difficult to achieve. 

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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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