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Virgin Money shares are up 20% despite losses. Here’s what I think

When I woke up yesterday, Virgin Money’s (LSE:VMUK) share price was trading at £181, which was 22% higher than the previous day’s close. That’s a significant share price move for any major company, let alone one that has just declared a wide loss for the past year and a suspension of its dividend. 

These losses reflect the impact of an intense consolidation and re-branding effort over the past year. Previously known as CYBG, the holding company was re-branded as Virgin Money after it acquired Sir Richard Branson’s challenger bank for £1.7bn. The company also owns Clydesdale and Yorkshire banks. 

Now, the combined entity has declared a £194m loss for the trailing 12 months, a 7% drop in earnings before taxes and a suspension of its 3.1p per ordinary share dividend. The stock initially took a beating, but it seems investors have now reassessed the company’s prospects and have revalued the business much higher. There seem to be two reasons for this. 

Losses due to temporary costs

Back in September, Virgin Money warned investors that the costs associated with Payment Protection Insurance (PPI) claims could be as high as £450m. PPI claims have been a chronic issue for Britain’s banking system for years. 

Meanwhile, the costs of taking over the Virgin Money brand and securing a single banking license pushed the company deeper into the red. 

However, a surge in PPI claims and acquisition costs are far from perpetual. I expect investors will see lower costs next quarter once the brand has been fully integrated and PPI provisions are fulfilled. 

Core business growing

Meanwhile, the core business seems to be firing on all cylinders, at least in terms of growth. Business lending and personal lending expanded by 4.5% and 16.1% respectively this year. Experts have attributed this to the popularity and public awareness of the Virgin brand. 

Management’s decision to cut dividend payments is another positive sign for long-term growth. The team can now hold back more of its annual cash flow and reinvest in expanding the brand.

Investors who recognise the combined entity’s growth potential and long-term efficiencies seem to have bolstered the stock price this week. However, despite the surge, the bank still trades at relatively low valuations. 

The stock currently trades at 4.44 times annual earnings before taxes per share and 0.49 times book value per share. That valuation may be in line with some major banks, but Virgin’s growth rate is much higher due to its smaller size. In other words, the stock seems underpriced. 

Foolish takeaway

Sir Richard Branson’s Virgin brand seems to have helped this company avert disaster. Rising PPI claims and squeezed margins have been offset by the growth in Virgin Money’s personal and commercial lending operations. Meanwhile, the stock seems oversold, which could be the reason why it surged by double-digit percentages this week. 

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VisheshR has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.