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Royal Bank of Scotland Group plc: A Contrarian Opportunity?

Royal Bank of Scotland (LSE: RBS) (NYSE: RBS.US) is the bank without friends. Just yesterday its house broker UBS issued a ‘sell’ recommendation, with a target price of 300p against today’s 350p. According to the Financial Times, that’s the fifth broker within a month to turn negative on the stock.

UBS said kind words about the bank’s management while silently slipping the knife between its shoulder blades. It reckons a change in focus from balance sheet restructuring to business restructuring “should underpin operating improvements and improve business efficiency”. But it thinks the share price already discounts progress over the next two years, and sees all the risk on the downside.

Pressure

It’s not just the City that has the knives out. The bank has recently been forced by the Government to create an internal ‘bad bank’ — five years after it might have made commercial sense. Politicians of all hues attack the payment of bonuses, while the Labour party is pitching for the largest UK lenders to be forced to sell off branches. That’s on top of the 316 branches RBS is already being made to sell by the European Commission.  Meanwhile, the FCA is investigating allegations that the bank deliberately drove companies into administration.

Now will RBS be free of political interference soon? Business secretary Vince Cable had predicted it would take more than five years before it could be privatised. That’s borne out by yesterday’s UBS report, which predicts the share price won’t rise above the 500p Government buy-in price until the end of the decade.  Investors might think it a nightmare scenario if the bank comes under majority control of a Labour administration next year.

Contrarian

All that adds up to a convincing bear case. But — sometimes — it can pay to take a contrarian standpoint. When all the bad news is apparent and fresh, share prices can over-react.

So it’s worth thinking about how RBS might surprise on the upside. I see three possibilities:

  • The fact that RBS will benefit from the UK’s vibrant economy and housing market — just like rival Lloyds — is often forgotten;
  • A stronger and more confident US economy means RBS might achieve a better-than-expected result from sale of Citizens Bank;
  • The Irish economy could bounce back strongly this year, aided by its return to financial markets and a booming UK economy. That could have a profound effect on RBS’s problem loans.

RBS would not be my choice of UK bank to invest in right now - but it would be premature to write it off. To find out how the UK banks do compare, I recommend you take a look at 'The Motley Fool's Guide to Investing in Banks'. It shows how the UK's five FTSE 100 banks compare on six key valuation metrics. What's more it explains each of the measures, to help you monitor your banking shares as new results are published. It's completely free and without obligation -- just click here to download it.

 > Tony does not own any shares mentioned in this article.