I am always looking for cheap UK shares to add to my portfolio. And there is one business I think looks incredibly undervalued right now, compared to its potential.
When CYBG completed the merger of its peer, Virgin Money (LSE: VMUK), in the middle of 2018, investors pushed shares in the enlarged lender up to an all-time high of more than 350p.
However, the company has come under pressure since the group completed the deal. The stock has slumped 50% from this all-time high, as the bank has failed to live up to expectations.
Significant challenges
In fairness, there have been some significant challenges for the group to overcome along the way. The integration process was a bit trickier than initially expected and then the coronavirus pandemic arrived. That caused significant disruption across the enterprise when it should have been concentrating on expanding its bigger footprint.
After two years of disruption, it looks to me as if this business is now getting back on track. According to the company’s latest trading update, covering the three-month period to the end of December, the lender has made solid progress in refocusing its business model away from low-cost credit.
The overall net interest margin, which measures the gap between the cost of the bank’s cash (usually savings deposits) and the amount it charges borrowers, rose to 1.77% from 1.70% in the previous quarter.
While overall lending balances declined, the company reported an increase in unsecured lending. This is typically credit card lending, which has a significantly higher interest rate than products such as mortgages.
A cheap UK share in transition
Virgin Money is in the middle of a significant transition. The company is trying to improve its digital proposition, reduce costs and increase options for consumers. It is also focusing on customer service rather than the race to the bottom that has persisted across the UK banking industry in recent years.
This strategy is not risk-free. It assumes consumers are willing to pay a bit more for better service. That is not guaranteed in the banking industry.
Meanwhile, some of the company’s peers have considerably deeper pockets and can offer much better deals. This could push customers away from the business in the long run, holding back growth.
Still, looking at this cheap UK share, I think its depressed valuation more than makes up for these potential risks. Indeed, at the time of writing, the stock is trading at a forward price-to-earnings (P/E) ratio of just 6.5 and a price-to-book (P/B) value of 0.5.
I believe these metrics fail to take into account the company’s potential. In fact, I think the market is focusing too much on what the company was, rather than what it can be as the UK economy returns to growth, interest rates rise and the lender’s growth strategy moves forward.
With these tailwinds behind it, I reckon the market may re-rate the shares to a sector-average multiple.
Considering many of the company’s peers are trading at a double-digit P/E multiple and a book value of at least one, these figures could indicate that the stock could double from current levels.
Based on this potential, I would be happy to buy the shares for my portfolio today.
