I wouldn’t buy shares in the big-name UK-facing banks now, such as Lloyds Banking Group (LSE: LLOY), because growth is off the agenda. Lloyds expects earnings to come in flat during 2018.
But one firm shines like a beacon of light across the heaving quagmire that is the banking sector on the London stock exchange, and that company is Virgin Money Holdings (LSE: VM).
Sound progress
In a trading statement released today, Virgin Money revealed sound progress in its British retail banking business. Mortgage balances are up 3% compared to three months ago, credit card balances elevated 8% and deposit balances lifted 3%. The firm continues to win over customers and is building market share.
Chief executive Jayne-Anne Gadhia puts the ongoing operational momentum down to the firm’s “customer-focused strategy of growth, quality and returns,” asserting that the company’s good results demonstrate the benefits of a low-risk business model, strong balance sheet and a focus on operational excellence.
Something is going right for sure because City analysts following the firm expect earnings to shoot up 17% this year and 13% during 2018, which trounces the likes of Lloyds. Both firms compete for the same customers and offer similar services. It looks like Virgin Money is winning.
Outlook and valuation
There’s no doubt that the UK banking market is competitive, but Virgin Money is confident that it can deliver against expectations for 2017 and today reaffirms its guidance for the full year.
With double-digit percentage earnings growth expectations on the table, we might expect a double-digit valuation. However, at today’s share price around 325p, Virgin Money trades with a forward price-to-earnings (P/E) ratio of just over eight for 2018, and the forward dividend yield runs at almost 2.4%.
Those anticipated forward earnings should cover the dividend payout around five times, which looks healthy. With high cover from earnings like that the directors must see plenty of opportunity for further growth, otherwise they would likely put more of the firm’s incoming cash flow into the dividend rather than investing more money in the business.
Out of kilter?
Meanwhile, at today’s share price of 67p, Lloyds Banking Group’s forward P/E ratio runs at 9.6 for 2018 and the forward dividend yield at around 6.2%. Anticipated earnings should cover the dividend payout just under 1.7 times. With so much cash inflow going into the dividend, my assumption is that the directors see little opportunity to invest for growth.
Lloyds’ price-to-book ratio sits around 0.98 and Virgin Money’s at 0.86 or so. Despite all the earnings growth that Virgin Money expects, the firm’s valuation is lower than Lloyds in terms of the forward P/E ratio and when comparing share prices to asset values.
All banking businesses are cyclical and can suffer from valuation-compression as the wider economic cycle unfolds and after a long period of strong earnings. Yet Virgin Money is growing and gaining market share, and I don’t think it deserves to be priced lower than Lloyds, which has a chequered history and an arguably less entrepreneurial culture.
