Banks in general have done well over the past few years as interest rates have risen. But their stocks have been less buoyant, although it surprised me to note a FTSE 250 bank that has experienced a massive 57% drop over the past year, with a 70% fall over a five-year horizon. What’s going on here?
The sorry story
I’m talking about Close Brothers (LSE:CBG). The UK-based merchant bank does offer some retail banking services but is very small in this regard. That is why some might not be that familiar with it. The company provides services to corporates, as well as having an Asset Management division and a trading and investment business, known as Winterflood.
For a bank so see such a steep drop in the share price, I know that there must be some serious problems. One I’ve noted came last year, with lender Novitas. Close Brothers bought the company back in 2017, but various troubles meant the firm had to make provisions for bad loans.
This severely impacted overall financial results last year, with a £114.6m provision in relation to Novitas.
Another factor has been underperformance with Winterflood. In the latest quarterly update, the division posted a £2.5m loss. This was blamed on “a further weakening of investor appetite and market uncertainty.” Yet in reality, this division has been underperforming for some time now.
Looking at the impact
The business is still profitable, having posted a profit before tax of £112m in the last financial year. Yet this was down over 50% from 2022. So on that movement alone, the comparable fall in the share price looks logical.
Another way to judge the fall in price relative to earnings is the price-to-earnings ratio. Even with the steep drop, it stands at 7.72. I use a benchmark of 10 as a fair price. So although it’s below this, it isn’t significantly undervalued.
If it isn’t really a value stock, what about income potential? The dividend yield has spiked to 16.87%. This is incredibly alluring. At the moment, there’s been no sign of a cut to the dividend, and the business is still generating profits that could be used to fund the payout.
Yet I wouldn’t be surprised to see the dividend chopped in the future as I imagine the firm will need to retain profits to ease any potential cash flow issues.
Not this time
I’m a big fan of the banking sector and feel it can generate good share price returns for investors in the long run. As a mature area of the market, dividends are another perk that most banks pay out.
Yet with Close Brothers, I struggle to get excited about the potential for it to outperform in coming years. I don’t see it as being truly undervalued even despite the share price fall. As a result, I’d prefer to buy other banks to get exposure to the sector.
For investors who want to take on a higher level of risk, there could be large returns to be made with this one. Yet I don’t believe it’s worth it.
