With the government commencing the sale of its stake in RBS (LSE: RBS), it signals the beginning of the end for one of the most challenging periods in the banking sector’s history. Certainly, things could have been much worse for the UK economy if the government had not stepped in with a huge injection of capital to save the banking sector and keep banks such as RBS in operation. However, now that the sector is improving rapidly, it is time for the government to sell down its stake and walk away – even if it means making a loss on the taxpayer’s behalf.
The key reason for this is that the government holding a majority stake in RBS dampens investor sentiment in the stock. In other words, RBS is still seen as something of a ‘basket case’ by many investors, with its part-nationalised status acting as a warning light against investment and a reminder that less than a decade ago it came close to being insolvent.
As a result of the government selling down its position, then, investor sentiment in RBS is likely to become much more positive. The market is likely to begin to see RBS in a new light and focus on the strength of its new strategy of rationalising and restructuring the business, as opposed to concentrating on its past mistakes.
Looking ahead, RBS is forecast to grow its pretax profit from just over £700m in the current year to over £2.6bn in 2016. That would represent a strong performance and puts RBS on a forward price to earnings (P/E) ratio of 12.4. Although relatively appealing, the real potential for RBS is in improving its efficiency over the medium term. It still lags behind rivals in terms of its cost:income ratio and, while it hopes to pay a dividend in the near future, it is likely to be rather small.
As such, and unlike most of its rivals, RBS still has the potential to transform its profitability and income prospects moving forward. And, with it trading on a price to book (P/B) ratio of just 0.65, there is a wide enough margin of safety on offer for investors to pile in and take a risk on RBS being able to successfully execute its strategy.
Meanwhile, banking sector peer, Santander (LSE: BNC), is itself in a period of transformation following a placing last year and a decision to slash its dividend. Although painful in the short term, both of these measures have significantly strengthened Santander’s financial standing and set it up for a prosperous long term growth outlook.
Furthermore, like RBS, Santander has a wide margin of safety since it trades on a P/B ratio of just 1. This indicates that it has significant upside potential and, with a P/E ratio of just 12, its shares appear to be all-set to turn the tables on a disappointing 2015 that has seen the bank’s valuation plummet by almost 20%.
So, while neither bank may be popular at the moment, both appear to be well-worth buying. As for whether you should beg, borrow or steal to buy them, RBS’s huge discount to its net asset value and the government’s continued sale of its shares make it the standout option, with its share price set to make a stunning comeback over the medium to long term.
