The last time I covered the Royal Bank of Scotland (LSE: RBS), I noted that while the stock looked attractive from a valuation perspective, its uncertain outlook could be a sticking point for investors who might have been considering adding the shares to their portfolio.
Unfortunately, not much has changed since I wrote my last article. The outlook for the UK banking sector is still shrouded in uncertainty and, with this being the case, I think it might be worth selling shares in RBS and investing your money elsewhere.
Time to sell
The good news is recent market declines have thrown up plenty of bargains for investors. Northgate (LSE: NTG) is a great example.
This commercial vehicle hire business has, in my opinion, a much brighter outlook than RBS because it operates across the UK, Spain and Ireland. What’s more, unlike RBS, the company isn’t subject to strict regulations and is highly cash generative (it’s also quite easy to understand unlike RBS’s giant and complex balance sheet).
That being said, if there’s a recession in the UK following Brexit, RBS and Northgate will both suffer. However, because Northgate leases its vehicles on relatively short contracts, it’s not exposed to the same kind of credit risk as RBS. Indeed, RBS recently had to put aside £100m to prepare for loan losses in the event of a messy Brexit. Some analysts have speculated that this could be just the start of what eventually could turn out to be hundreds of millions, or even billions, of pounds in loan losses, which could force the bank to eliminate its dividend, or raise capital.
A billion pound plus loss is the worst case scenario for the bank, but I think it illustrates how damaging Brexit could be to the business. In comparison, if the UK plunges into recession after Brexit, Northgate’s Spanish division will offer some cushioning and, if history is anything to go by, the company will continue to turn out a steady stream of profit.
Business as usual
According to my research, even in the financial crisis, customers continued to come to Northgate to rent vehicles. The utilisation rate of the company’s rental fleet dropped to 84% in the UK in 2009, before rising to 91% across the business in 2010. A contracting economy is a mixed blessing for the group because, on the one hand, demand will fall as companies try to cut back on spending, but on the other hand, it becomes harder for businesses to borrow money to invest in new vehicles, so they turn to rental companies like Northgate to fill the void.
In other words, you could have a situation where RBS is turning away customers who then go straight to Northgate. With this being the case, I think Northgate could be a good investment for your portfolio in 2019.
Based on current City earnings estimates, the shares are changing hands at 10.5 times forward earnings. There’s also a dividend yield of 4.6% on offer, covered twice by earnings per share. Even though current estimates suggest RBS might be a better investment from an income perspective, with a dividend yield of 4.8% pencilled in for 2020, for the reasons outlined above, I reckon Northgate is an all-round better buy.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Northgate. 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.