Improved confidence over the UK economy has helped lift NatWest Group’s (LSE:NWG) share price higher in 2023. Yet at current prices, the FTSE 100 bank still seems to offer excellent all-round value.
NatWest shares trade on a forward price-to-earnings (P/E) ratio of 6.9 times. They also carry a FTSE index-beating 5.7% dividend yield for this year.
I’m a big believer in the long-term investment potential of value stocks. But I’m not planning to buy this high street bank’s shares for my portfolio any time soon. I think its low valuation reflects the colossal risks it exposes investors to.
Here are three reasons why I’m avoiding NatWest’s cheap shares, at all costs.
#1: A mortgage market meltdown
It’s not time for panic just yet. But recent data concerning mortgage approvals should come as a major concern for the bank. NatWest is the country’s second-biggest mortgage provider, behind Lloyds.
Bank of England data shows that loan approvals fell for the fifth successive month in December. In fact, the 39,600 mortgages that were signed off for house purchases marked the lowest number since 2009 (excluding the pandemic).
Approvals could continue sliding too as the economy toils and homebuyer confidence sinks. Higher-than-usual interest rate hikes could also continue to weigh on lending activity.
#2: Bank of England cools on rate raises
Speaking of interest rates, clues are emerging that the Bank of England (BoE) could be rowing back on plans for further increases. This could cause a major problem for Natwest by reducing the difference in the interest it pays savers versus what it charges borrowers.
BoE governor Andrew Bailey claimed this week that additional rate rises are not “inevitable” in the coming months. Expectations of toppling inflation as 2023 progresses has caused a number of Monetary Policy Committee members to publicly cast doubt on additional hikes from current levels of 4%.
“It is clear from Mr Bailey’s speech that committee is placing more emphasis on the substantial tightening already delivered and would like to call time on its hiking cycle as soon as it feasibly can,” Pantheon Macroeconomics chief UK economist, Samuel Tombs, has said.
#3: A prolonged economic downturn
Banks are among the most economically sensitive companies out there. Bad loans can spiral out of control and revenues growth can grind to a halt. The £377m worth of credit impairments that NatWest chalked up in 2023 is evidence of this.
Unfortunately for the banks, Britain’s economy looks set for a protracted period of weakness. The economic fallout of Brexit will be long and severe, while Britain is also enduring a painful Covid-19 hangover.
Other structural problems like labour shortages, sky-high public debt and low productivity will also restrict the profits potential of NatWest and its peers.
As a long-term investor, I’m encouraged by the huge progress NatWest is making in digital banking. This could deliver massive benefits as consumer habits change and online becomes increasingly important.
But, on balance, I believe the business is one that should be avoided.
