Could this challenger become the next Lloyds Banking Group plc?

Shares in challenger bank CYBG (LSE: CYBG) are falling today after the company reported its interim results for the six months to the end of March. Despite concerns about the state of the banking sector, particularly challenger banks after Brexit, CYBG’s results struck a relatively upbeat note.

Underlying earnings per share rose 25% to 9p as underlying profit before tax rose 15% to £123m. Underlying return on tangible equity increased to 6.3% in the first half from 4.5% in the year-ago period. The group’s common equity tier 1 capital ratio came in at 12.5% at the end of the period.

A unique business

Unlike other challenger banks, which have focused on one particular area of the market, CYBG is unique in its presence across UK personal and small business accounts. The group operates under the Clydesdale Bank, Yorkshire Bank and B brands and can offer a range of services to customers through branches, it’s online offering and brokers. And just like larger peer Lloyds, by maintaining a simple business model, focusing on the client’s experience, steady growth and capital generation, CYBG could generate huge returns for investors over the next few years.

Growth targets

Management has laid out a number of key performance targets for the banking group over the next two years. These objectives include mid-single-digit percentage annual loan book growth to both the UK retail and SME markets, a return on tangible equity in the double digits by 2019, and a tier 1 capital ratio of 12% to 13%.

This strong balance sheet will give management scope to return cash to shareholders, and that’s exactly what it plans to do with a modest inaugural dividend planned for 2017. By 2019, the payout is expected to rise to 50% of earnings. If earnings growth continues on its current trajectory, the 50% of earnings payout target could see CYBG yielding around 4.5% in two years time.

For the fiscal year ending 30 September 2017, City analysts are expecting CYBG to earn 18.2p per share rising to 21.2p per share for the following fiscal year. If the company can achieve double-digit earnings growth for the financial year ending 30 September 2019, it’s not unreasonable to suggest that for the year the company will earn around 25p per share.

Paying out of 50% of these earnings would give a dividend yield of 4.5% at current prices.

The bottom line

So, just like its larger peer Lloyds, it looks as if CYBG is on track to become an income champion over the next few years. If you want to take advantage of this, now could be the time as shares in the banking group currently trade at a relatively attractive forward earnings multiple of 15.4 falling to 13 for the year after.

Moreover, after today’s declines, the company trades at a discount to tangible net asset value. In today’s half-year update tangible net asset value was reported as being 283p per share, around 5p above the share price of 278p at the time of writing.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.