Given the uncertain outlook for the UK economy as Brexit talks commence, a 30% capital gain by 2019 may sound somewhat unlikely. That’s especially the case for a company which is UK-focused and that operates within the financial services sector. However, a results release on Tuesday suggests the company in question offers strong growth potential. When coupled with a low valuation, its shares could deliver stunning capital gains over the medium term.
Virgin Money (LSE: VM) recorded an increase in underlying profit before tax of 33% in 2016, with a rise in customer loan balances of 19% against strict underwriting principles. Much of the growth was due to a higher volume of customers, with its customer base rising by 15% to 3.3m at a rate of over 35,000 per month. This was driven largely through digital channels, where the bank is expected to invest heavily in the coming years.
Virgin Money’s gross mortgage lending grew by 12% to £8.4bn. This gives it a 3.4% share of the lucrative mortgage market and means that it is gradually transitioning from a challenger bank towards a more established entity. Its capital position remains strong, with a common equity tier 1 (CET1) ratio of 15.2% and a total capital ratio of 20.4%. If the UK economy does experience a slowdown as a result of Brexit, the company appears to be well-placed to survive.
Over the next two years, Virgin Money’s bottom line is forecast to rise by over 25%. Certainly, there is scope for a downgrade to this figure if the macroeconomic outlook deteriorates. However, given that the bank’s valuation includes a wide margin of safety, a share price gain of 30% could be on the cards even if trading conditions become unfavourable.
For example, the company’s shares have a price-to-earnings (P/E) ratio of only 10.9, which equates to a price-to-earnings growth (PEG) ratio of only 0.9. This indicates a share price gain of 30% could take place and still leave Virgin Money trading on a relatively enticing valuation. And since it lacks the legacy issues of a number of its larger, more established peers, it could even be viewed as lower risk in the near term.
Of course, a number of other banking stocks could deliver high returns by 2019. Fellow challenger bank Aldermore (LSE: ALD) has a P/E ratio of just 9 and yet is forecast to grow its bottom line by 11% this year and by a further 6% next year. This puts it on a PEG ratio of only 1.1, which while higher than that of Virgin Money still suggests a higher share price is warranted.
Aldermore’s new branding and marketing campaign could improve its performance over the medium term and lead to higher profitability than forecast. Its focus on business lending means it may have some scope to expand into what remains a highly profitable mortgage market. As such, now could be the perfect time to buy it, although its sector peer could be an even more profitable investment between now and 2019.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK 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.