Barclays: Disappointing Quarter But Thesis Fully Intact
Summary
- Headline numbers for Q1’2021 are impressive.
- Mr. Market however is looking under the hood and is focused on the going-forward narrative.
- The concerns are with the sustainability of investment banking revenue as well as the cost trajectory.
- At the same time, Mr. Market overlooks the potential tailwinds.
- I remain bullish and see the latest price action as consolidation and profit-taking.
The Q1'2021 headline numbers for Barclays (NYSE:BCS) were impressive at a return on tangible equity (RoTCE) of 14.7 percent. This is the statutory accounting number and not an "adjusted" metric, and it wasn't flattered by massive loan loss reversals either whilst fully incorporating conduct/litigation costs that many other firms label as "notable items".
The outperformance was driven by the Investment Bank ("IB") numbers that delivered above 20 percent RoTCE for the quarter. The Consumer segments, as expected, are still very challenged by a combination of low interest rates as well as lower outstanding balances in unsecured lending. On the positive side, the credit loss environment looks extremely benign (given the early part of the cycle) whilst huge loan loss reversals are expected in coming quarters.
BCS has been and still remains very conservative in its loan loss provisioning approach when compared to its U.S. peers.
Having said all that, Mr. Market didn't like the results at all, and the share price plummeted down high-single-digit on the day.
What is the Market Concerned With?
There were essentially two key reasons for the market concerns:
- The over-reliance on the IB revenues which are not viewed as sustainable, and
- increased cost trajectory and/or otherwise lack of absolute guidance on costs.
As noted above, the IB delivered a RoTCE in excess of 20 percent (ex-corporate line). Mr. Market is not seeing this as sustainable and rightly so. The commentary from some of the other banks (such as Deutsche Bank (DB)) indicates some normalization of trading revenue already manifesting late in Q1 and April.
Additionally, the revenue mix in the investment bank raised concerns as well.
(Source: Company's Q1'2021 presentation)
As can be seen from above, whilst Equities and Banking fees performed very strongly, FICC however was quite challenged (29 percent down year on year) and underperformed both the U.S. and European peers (that were typically up >20 percent).
There was no clear explanation for the underperformance in the important FICC segment. Mr. Staley indicated in the earnings call that some are attributable to product mix and also alluded to increased competitive pressures as European banks are scaling back on their retreat.
Reading the tea leaves, I strongly suspect much of the underperformance is attributable to DB's reclaim of market share in the IB. DB is exceptionally strong in FICC and BCS probably lost some market share there.
The second concern articulated by Mr. Market is the cost trajectory. Analysts are very much focused on definite cost guidance to feed into their models. BCS management, on the other hand, was almost at pains during the earnings call not to provide absolute cost numbers targets and especially so for 2022.
In reality, there are a number of puts and takes. BCS has increased variable compensation accruals (somewhat mechanically) in Q1 for the IB in line with increased profitability. This is an important lever for the firm to manage both staff retention as well as allow for flexibility should IB revenue disappoint going forward. Secondly, there are expensive legacy debt issuances that are callable in the second half of 2021. This should result in material savings in funding costs (~GBP100 million annually). Thirdly, management is planning a massive real estate rationalization in 2021. BCS occupied a lot of expensive office space in central London - in the wake of the pandemic, the opportunity to reduce occupancy costs is enticing.
Putting all the above together, analysts were hoping for firm guidance that costs in 2022 will be lower than in 2021.
Management, on the other hand, did not want to yield. The key reasons are, as outlined above, to do with variable compensation. Additionally, BCS wants to leave room for additional investments in digitizing the bank as well as investments in the Payments area.
The net impact of the above was the reason for the sell-off on Friday.
The Payments Opportunity
Mr. Staley has mentioned BCS's focus on developing the Payments vertical several times in recent quarters. During Q1, though, for the first time, he outlined the revenue growth target for this business at GBP900 million.
(Source: Company's Q1'2021 presentation)
The upside for BCS's share price is crystal clear, especially when one considers the valuation attributed by the market to the likes of Square (SQ) and Stripe (STRIP).
Mr. Staley believes that BCS is extremely well-positioned to aggressively grow in this space with a double-digit CAGR in the next three years. BCS at the moment already generates GBP1.7 billion of revenue from this vertical albeit at much lower margins than competitors.
Mr. Market, however, remains unconvinced at this stage. So at the moment, none of the upsides is factored in the share price, so it is effectively a "free" call option for shareholders.
IPBR ratings on European Banks
So far, I have covered BCS, DB, and Credit Suisse (CS) on Seeking Alpha.
I was "very bullish" on Barclays earlier on, but then downgraded to "bullish" as the price catapulted higher and the risk/reward turned from a "no-brainer" to a solid, long-term "buy". I see the recent price action as consolidation and profit-taking. I also recognized that DB's retracing of market share in the IB is a negative for BCS.
(Source: Seeking Alpha)
The catalysts for BCS are the continued recovery in the consumer segments as the economies reopen and rebasing of the IB revenue to post-pandemic "new normal" which I still expect to be higher than the 2019 baseline.
On DB, I have turned from "bullish" to "very bullish" in recent months due to market share gains in the IB as well as clear signs that the latest restructuring is going to be successful. The latest Q1 results validated my thesis and the share price catapulted higher. DB is still very cheap currently at ~0.5x tangible book value.
(Source: Seeking Alpha)
I was neutral/negative on CS in the wake of the Archegos fiasco as I was waiting for the downstream ramifications to play out (such as regulatory overreach, capital raise, scaling back of the investment bank, and generally negative market sentiments). I am somewhat more constructive now at the current share price and intend to submit an article on CS in the near future.
(Source: Seeking Alpha)
Final thoughts
The concerns raised by the market on the sustainability of the IB revenue trajectory are absolutely valid. I do not dispute this at all.
However, market participants are also ignoring the obvious potential tailwinds that include:
- Recovery in the Consumer segments (likely to manifest in 2022) that should drive returns back up to mid-teens RoTCE.
- Massive loan loss provisions reversals (Q2'2021 and beyond).
- The Payments vertical opportunity as discussed above even if only partially realized.
- Rebasing of the IB revenue to sustainable levels that are still above 2019 levels.
- Massive potential for capital returns in the form of buybacks and dividends.
- Additional upside from higher interest rates and/or steepening of the yield curve.
- Share price trading at the well-below tangible book (currently at ~0.65x).
Most important, however, is the quality of management. Mr. Staley has managed to nurture the IB from a RoTCE of low- to mid-single-digit to earning its cost of capital whilst capturing significant market share in the last two years. His vision of a transatlantic universal bank comprising of consumer and investment banks was clearly validated in the recent pandemic. The diversification provided by the IB means that BCS is well-positioned coming out of this crisis with strong capital ratios and quality franchises.
This article was written by
Analyst’s Disclosure: I am/we are long DB, BCS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (10)
Actually BCS I don't have a strong opinion. :-)
Nice research
