Why Royal Bank of Scotland Group plc Should Be Avoided

RBSRoyal Bank of Scotland (LSE: RBS) (NYSE: RBS.US) surprised many of us on 1 August when it reported a first-half pre-tax profit of £2,652 million, up from £1,374 million for the same period a year previously. The bank put this down to “more favourable credit conditions and good results from RBS Capital Resolution, with a consequential beneficial impact on capital ratios

But chief executive Ross McEwan warned us that “These results are pleasing but no one at this bank is complacent about the challenges ahead“.

A long way to go

And he’s right — there’s a good deal more to be done before RBS can be said to have recovered from its shredding at the hands of ex-Sir Fred. And the benefits of a single-period of good-looking profit should not be overestimated in these still-dark days.

A common equity tier 1 (CET1) ratio of 10.1% at the end of June, up from 9.4% in March and 8.6% at the end of 2013 is good going, but on many scores RBS is still lagging behind fellow-sufferer Lloyds Banking Group — Lloyds recorded a CET1 of 10.7% for the end of March, up from 10.3% at December 2013.

Comparisons of the two on fundamental measures are quite telling too.

Where Lloyds is on a forward P/E of under 10 based on full-year forecasts, the equivalent multiple for RBS stands as high as 12.7 — and that’s higher than Barclays, which is on a forward P/E of 10.5 with forecasts of £6.2bn in pre-tax profit this year and a dividend yield of 3.3%.

No cash

RBS is not back to paying dividends yet, and there’s unlikely to be any cash seen until the second half of 2015 at the earliest — and if you’re happy with a predicted yield of 0.5%, then good luck to you.

But Lloyds is already expected to seek approval from the Prudential Regulation Authority to resume dividends in the second half of this year, and its capital ratios suggest it will be successful. Forecasts indicate a 1.8% yield this year, but analysts have 4.4% penciled in for 2015.

To sum up, it’s hard to assess RBS’s valuation at the moment, because it’s at such an early stage in its recovery, and I might be way off with my pessimism — a high-looking P/E might well be justified right now.

Too much uncertainty

But we just don’t know when sustainable profits will be back, and the last thing I’d want to be doing right now is taking a risk on the banking sector — I reckon there are safer bets out there than RBS right now.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool 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.