Rumours of the United Kingdom’s economic death post Brexit have been greatly exaggerated. In fact, all recent UK economic data has been buoyant, driving expectations that the Bank of England will raise rates multiple times in 2018. This positive economic outlook has lifted the British Pound sharply as the chart below confirms.
British Pound (GBP) +12.7% over the last 12 months
UK 10yr Gilt yields have also risen over the last six months as UK economic data strengthened.
The final macroeconomic chart is the UK unemployment rate, which has fallen to 4.30% which would be considered “full employment”.
Those three charts paint a bullish macroeconomic picture for the UK domestic banking sector. Full employment, rising yields, and strong economic growth are tailwinds for domestic UK Banks.
I always believe the best share price returns come from top-down meets bottom-up ideas. That’s exactly how we run the AIM Global High Conviction Fund. We look for macroeconomic tailwinds and then pick the bottom up stock that we think has the greatest leverage to those macro tailwinds. In this case, we continue to choose ASX listed CYB as it gives us the further added attraction of likely GBP appreciation vs. the AUD as CYB is a 100% GBP earner.
CYB is a classic “spin-off” from a larger entity. It was the National Australia Bank’s “problem child”, but now set free from the NAB bureaucracy the company has been able to start reaching its potential as a UK regional bank.
This is also a classic “self-help” story, where focused management is ripping out costs and making the business far more efficient. That is leading to better margins, greater capital generation, higher ROE and now dividends starting again to shareholders.
On Tuesday night in London, CYB released its 1st quarter trading update up to December 31st. Trading has been in line with expectations, and the company reiterated its FY18 and medium-term guidance. The stock fell with all EU/UK equities in the sector that night in what I believe had nothing to do with the trading update.
The Q1 trading update confirmed continued sustainable growth in asset and deposit balances, despite the competitive UK banking environment. CYB experienced strong mortgage growth of +7.4% (annualised), core SME growth of +1.4% (annualised) with 567m GBP of new lending in Q1, deposit balances +14.8% (annualised), driven by strong performance in current accounts and fixed-term deposits. Importantly, asset quality remains strong with a net cost of risk of 12bp (annualised) in line with expectations.
NIM (net interest margin) of 2.16% was marginally dragged down by strong deposit growth. The increase in deposit balances is to enable pre-funding of lending growth.
The CET1 CAPITAL ratio was a strong 12.4% as at Dec 31st. CYB is holding excess regulatory capital which will start finding its way back to shareholders over the next 18 months and is a core part of the investment attraction of CYB.
David Duffy, CEO of CYBG PLC said “We have delivered another solid quarter of growth despite a competitive operating environment, seeing continuous momentum in both mortgage and SME lending. While the economic outlook remains uncertain, we remain focused on delivering sustainable and prudent growth and are confident we will deliver our guidance for 2018 and the medium-term.”
“We also continue to take major strides in transforming CYBG into the UK’s leading digitally-enabled challenger bank, positioning us strongly for the future banking landscape. Our IB technology platform is ready for Open Banking today with full “plug & play” fintech capability, meaning we can offer real-time, integrated services for our 2.8 million customers”.
In terms of outlook Duffy said, “Despite the ongoing uncertainty in relation to the terms of the UK’s withdrawal from the European Union and its potential impact on the outlook for the UK economy, we remain confident in our ability to deliver the Group’s FY18 and medium-term guidance”.
All in all, this was a solid trading update from CYB, and I reiterate that the stock only fell because the entire sector fell that day. On that basis, I see an opportunity to accumulate more CYB shares at lower prices, and that’s exactly what the AIM Global High Conviction Fund has done in recent days.
It’s worth noting that CYBG is one of very few banks in the entire world currently giving forward guidance. To us, that shows real confidence that they will deliver that guidance and hopefully a touch more in the year ahead.
Below I am going to quote directly from my old colleague at Bell Potter, TS Lim. TS is the best bank analyst I’ve ever worked with and I continue to rate his work very highly. He is an excellent analyst who doesn’t get caught up in short-term noise.
TS said in a recent research report on CYBG:
“It’s relatively rare for banks to provide forward guidance in the current setting yet CYB continues to do so. Given CEO David Duffy’s previous success in turning around Allied Irish Banks, we believe he will repeat this at CYBG. The motivation to achieve and exceed CYB’s financial targets is further linked to performance rights that would largely vest over the same time horizon. Mr Duffy’s 2015 cumulative award shares are probably in the bag with all IPO targets having been met. While the 2015 cumulative underlying PBT target is undisclosed, this will likely be surpassed given the impressive 36% CAGR achieved in 2017 and 285 estimated in 2018. Likewise, our 2018 forecasts are also not that far away from the 2019 and 2020 target performance KPI’s under the respective 2016 and 2017 awards. CYB’s current guidance remains aggressive, but we believe this is largely due to its capacity to extract further cost savings from branch closures and support function and other organisational redesign. Starting with CYBG’s pre-IPO underlying cost-to-income ratio (CIR) of 75% and compared with the UK listed bank average of only 51% (comprising 57% for the average high St bank and 44% for the average new entrant), we assert that CYBG’s potential earnings uplift will be material. It remains our strong belief that reducing costs would be more achievable than increasing revenues ahead of Brexit in March 2019.”
In upgrading his recommendation to BUY and price target on CYB in Australia to $6.45, TS also wrote “We have rebased our underlying forecasts largely as a result of maintaining net interest margin (NIM) at 2.20% and factoring in 3% lower operating and administrative expenses”. These have resulted in +8-11% underlying earnings upgrades, with the material increment also reflecting our previously conservative view of cost reductions.” TS is forecasting a total shareholder return of greater than +15% from CYB over the next 12 months and I agree with the view CYB should head towards $6.50 over the year ahead.
Valuation and financials are compelling in my view. Buying CYBG on a price to book ratio of less than 1x is value. Yet we also see double-digit EPS growth for the next two years and a rising ROE and rising dividend yield. The price-to-growth ratio of around 1x is also cheap in our opinion.
All in all, we remain firm believers in the medium-term CYB investment case. We prefer CYB over any other ASX listed bank and believe it will continue to deliver stronger total shareholder returns than any other ASX listed bank, albeit it is a UK bank that just happens to be listed on the ASX due to its previous ownership by NAB.
If you’re looking to increase international exposure, but particularly UK exposure, I suggest you consider adding CYB to your portfolio. At AIM, CYB remains one of our high conviction investments.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
