Stock markets often rise on rumour and sell on the news. So when Royal Bank of Scotland Group (LSE: RBS) reported its first annual profit for nine years this morning, I wasn’t surprised to see the shares slide 4% lower in early trade.
As a shareholder, these short-term movements don’t worry me. What I’m looking for is concrete evidence that RBS is becoming a more profitable and well-capitalised bank. A bank that should soon be able to restart dividend payments.
Here I’ll explain why today’s figures have increased my confidence in this stock as a potential dividend buy.
A profit that’s bad news?
City analysts expected the bank to report a statutory loss of £592m for 2017. Today’s reported profit of £752m should have been a cause for celebration. Unfortunately this result came with a sting in the tail.
The only reason RBS was able to report a profit for 2017 was because it didn’t manage to settle a big mortgage mis-selling case with the US Department of Justice. Had it done so, the expected multi-billion pound fine would probably have pushed the bank to a loss.
To be honest, I’m not bothered about this delay. A settlement is expected soon and RBS made good progress with its other legacy issues last year, including winding down its ‘bad bank’.
I think it makes sense to focus on its underlying performance, which is now improving steadily.
A strong performance
A key measure of profitability for banks is return on tangible equity (RoTE). On an adjusted basis, this rose from 1.6% to 8.8% in 2017. I expect further gains over the next few years, but this is a solid result that places RBS ahead of rival Barclays, on just 5.6%.
This improvement in profitability came from falling costs and rising income. Adjusted operating expenses fell by 8.1% last year, while adjusted operating income rose by 4%. This gain was helped by a creditable 2.2% increase in net lending.
As a result of these changes, the group’s adjusted operating profit rose by 31% to £4,818m.
This strengthened performance helped the firm to generate a lot more surplus cash last year. Its Common Equity Tier One (CET1) ratio — an important regulatory measure — rose by 2.5% to 15.9%, well above the bank’s target of 13%.
This is important as it indicates the bank’s ability to fund future liabilities, handle bad debts and potentially pay dividends.
When will we get a dividend?
Broker consensus forecasts show that RBS is expected to pay a dividend of 9.4p per share in 2018, giving the stock a forecast yield of 3.4%. Although that’s a fairly speculative estimate at this stage, the bank did confirm today that it’s “committed to restarting capital distributions when permitted”.
The biggest obstacle to dividend payments is probably the US Department of Justice settlement I mentioned earlier. I expect this to be concluded in 2018, after which I think positive news on dividends is likely.
In the meantime, I’m happy that the stock continues to offer value. The shares trade at an 8% discount to their tangible net asset value of 292p and on a forecast P/E of 10.4. I rate RBS as a long-term income buy at current levels.
Roland Head owns shares of Royal Bank of Scotland Group. The Motley Fool UK has recommended Barclays. 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.