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Forget The Dividend Cut! Why Barclays PLC Is Still A Stunning ‘Buy’

Banking colossus Barclays (LSE: BARC) shook the market on Tuesday by taking the hatchet to its dividend policy, a move that sent the share price sinking 8% from the prior close.

For 2015 the bank elected to match the 6.5p per share payment afforded in recent years. But for 2016 and 2017 Barclays plans to slash the dividend to just 3p in a bid to bolster its capital reserves.

At current prices this translates to a mere 1.8% yield, lagging the FTSE 100 average of 3.5% by some distance.

PPI pains continue

Although naturally hard on shareholders, the decision to reduce the dividend would appear a wise one to protect the long-term health of the bank.

Barclays continues to be battered by the steady stream of PPI-related claims and this is likely to accelerate as we head towards a possible 2018 deadline.

The bank stashed away another £1.45bn between October and December to cover these costs, forcing pre-tax profits 8% lower to £2.1bn and taking total PPI provisions to-date to a colossal £7.4bn.

On top of this, Barclays has decided to offload its 62.3% stake in Barclays Africa Group during the next few years to help it meet its colossal misconduct costs.

On the right track

While it’s true this significantly reduces Barclays’ potential rewards from lucrative emerging markets, the move will allow the bank to concentrate on maximising returns from its core operations.

Fresh restructuring in line with ‘ringfencing’ requirements will see the bank split into two divisions — Barclays UK for its British retail customers and Barclays Corporate & International, which will house the company’s investment banking division.

Barclays noted that these new units would have generated “double-digit returns on tangible equity on a proforma adjusted basis” last year and expects them to command solid investment grade credit ratings.

Meanwhile, Barclays’ ongoing cost-reduction programme also continues to make the bank a leaner earnings-generating machine for the years ahead. Operating expenses excluding restructuring costs fell 4% in 2015, to £16.2bn.

Risk vs reward

So while Barclays still has plenty of work ahead to convince investors it’s on the right track, I believe that the risks facing the business are currently baked-into the share price.

The City expects Barclays to enjoy a 40% earnings rise in 2016, resulting in a P/E rating of just 7.3 times — any reading below 10 times is widely considered tremendous value. And this figure moves to just 6.3 times for next year amid predictions of a 14% bottom-line bounce.

Furthermore, the bank said that “we expect to pay out a significant proportion of earnings in dividends to shareholders over time” following this week’s cut.

The unexpected nature of this week’s dividend reduction will make many investors suspicious over such a statement, naturally. But I believe the prospect of terrific profits growth and a steady reduction in fines should indeed make Barclays a lucrative dividend play for long-term investors.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.