Maybe recent stock market volatility has exposed some bargains in the banking sector. Today I’m looking at Barclays (LSE: BARC), Lloyds Banking Group (LSE: LLOY) and Virgin Money Holdings (UK) (LSE: VM).
Challenged by cyclicality
City analysts following Barclays expect earnings to grow 36% this year and 19% during 2016. That looks like exciting growth at first glance, but the forward price-to-earnings ratio (PER) runs at just under nine, which seems modest for such apparent growth, so what’s up?
My guess is that the market is discounting Barclay’s cyclicality. Despite a recovery in earnings since the lean years following last decade’s credit-crunch, investors probably don’t expect growth rates to remain as punchy going forward.
I’m not expecting a valuation re-rating upwards with Barclays, as we mark time to the next macro-economic peak. If anything, Barclays strikes me as a little risky: earnings have done their recovering. I think Barclays’ valuation could compress further from here and drag on investor total returns until the next cyclical bottom arrives to a fanfare of falling bank profits and share prices.
Earnings set to decline
The big news at Lloyds Banking Group is the ongoing unwinding of the governments holding in the shares. Perhaps that ‘overhang’ is depressing the share price. However, there’s more to it, I reckon, because Lloyds faces the same cyclical challenges as Barclays.
City analysts following the firm think earnings will decline 6% next year after several years of recovery. That could be a stumble in growth and earnings could resume their uptrend, but even if they do, I’m not expecting the market to assign much value to such higher earnings. Growth in the UK will be difficult thanks to regulatory change and competition from other players, which includes new, leaner, and smaller outfits.
To me, mature banking businesses such as Lloyds remain unattractive.
A fast grower
FTSE 250 constituent Virgin Money Holdings (UK) has a market capitalisation around £1,732 million, which is much smaller than Barclays’ £42,787 million and Lloyds Banking Group’s £53,955 million. That situation is a big part of what makes Virgin Money attractive in the sector.
Relatively new, up-and-coming banks in the UK banking sector often come without the legacy issues and creaking inefficiencies present in the big lumbering dinosaurs of the old guard, such as Barclays and Lloyds. As nimbler and hungry enterprises, newer banks such as Virgin Money seem better able to capture growth in the competitive UK market. City analysts following Virgin Money expect earnings to grow 12% this year and 36% during 2016. With steady revenue growth too, Virgin Money looks like it’s gaining market share.
To me, the so-called challenger banks such as Virgin Money are more attractive than the big players because vibrant growth could overcome the constraints of the sector’s cyclicality to deliver a decent investor total return from here. The share price is off its highs, so now seems like a good time for me to do my own research and look more closely at the investment opportunity with Virgin Money.
