Upbeat prospects

Reporting on Tuesday was challenger bank Virgin Money (LSE: VM). The company’s profitability, earnings and underlying return on tangible equity were all in line with expectations in the third quarter of the year. It had a 3.5% market share of the gross mortgage lending market, while net mortgage lending of £3.2bn gave it a market share of 10%. The company has seen continued stable credit performance across mortgages and cards, with it reaffirming guidance for the full financial year.

Looking ahead, Virgin Money is expected to record a rise in its bottom line of 24% in the current year, followed by additional growth of 6% next year. Despite a positive outlook, it trades on a price-to-earnings (P/E) ratio of just 8.2 and this suggests that it offers a wide margin of safety at the present time.

Furthermore, the company is expected to increase dividends by 25% over the next two financial years. This may put it on a forward dividend yield of just 2.1%, however dividends are due to represent just 17% of profit in 2018. This means that dividend growth could remain at high levels over the long run. This could turn Virgin Money into a desirable income stock and mean that it has a mix of income and growth potential for the long term.

Investment potential

Also offering a bright future for investors is Aldermore (LSE: ALD). The lender has recorded a rise in its share price of 86% in the last year, with some of that growth coming in recent days as a potential offer being made for the business by FirstRand has been announced. While there is no guarantee that an offer will be made, the board of Aldermore has indicated that it would be likely to recommend a firm offer at the current level.

Of course, it appears to be cheap at its current share price. The company trades on a P/E of just 9.8 and is forecast to post a rise in its bottom line of 23% in the current year. And with dividends due to rise by 183% next year, it appears to have significant income appeal for the long run.

Certainly, the outlook for the UK economy is uncertain. Brexit talks are slow and this theme may continue, with there being a potentially negative impact on confidence among businesses and consumers. However, with such a low valuation and bright earnings, as well as dividend growth prospects, the company could be worth buying for the long term.

The post 2 cheap, high-yield growth stocks I’d buy appeared first on The Twelfth Magpie.

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Peter Stephens has no position in any 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.

This report has sparked speculation that Esure could fall prey to a larger peer after Wood offloads his stake. 

According to the Sunday Times, which broke the story, Wood has already been approached by other insurance company bosses about a potential deal, and he believes he can have a deal in place by next month. 

Chances of a takeover

It’s hardly surprising that Esure is being touted as a potential takeover target. The company is on track to nearly double revenue over the space of seven years, from £512m in 2012 to an estimated £900m for 2018. That said, profit during this period has remained stable. 

Still, the company has proven itself as a dividend champion since its IPO in 2013 having paid out 55p per share in regular and special dividends since 2013, around 18% of its IPO price. Analysts have pencilled in a dividend payout of 12.5p for 2017, giving a dividend cover ratio of 68%. Esure’s interim results showed that at the end of the first half the company had a solvency coverage ratio of 153%, indicating that the firm’s balance sheet is strong enough to support further generous payouts. 

Esure’s strong balance sheet and record of steady cash distributions makes the company an attractive target for both peers and investors alike. While you should never buy a company just because it’s a rumoured takeover target — in case the deal never materialises — as a standalone business, Esure is an attractive investment in its own right. 

With a prospective dividend yield of 4.7% and forward P/E of 14.7, the company looks like an attractive income and growth play to me at current levels. The prospect of a takeover is just a bonus. 

Dividend growth 

Shares in challenger bank Aldermore Group (LSE: ALD) have struggled to gain traction this year, falling 6% excluding dividends. However, while the shares have struggled, the underlying business has continued to expand. 

During the first half of the year, the company reported a 17% rise in operating income to £150m year-on-year and the bank’s tier one capital ratio rose 30 basis points to 11.8%, 20 bps below management’s 12% target required for dividend payments. For the full year, analysts have pencilled in projected earnings per share growth of 23%. 

At its current rate of growth, management expects Aldermore’s capital ratio to hit 12% by the end of the year. Based on this forecast, City analysts believe the bank is on track to pay a maiden dividend of 2.9p per share to investors for 2017. Next year, the payout could rise even further with analysts projecting a total full-year payout of 7.8p, giving an estimated dividend yield of 3.5%. 

Aldermore has also been touted as a potential takeover target thanks to its steady growth, cash generation and valuation. It may only be a matter of time before a suitor emerges as right now, Aldermore looks to be a cheap income and growth stock. At the time of writing, the shares are trading at a highly attractive 7.1 times forward earnings. 

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For the period, Aldermore reported a 6% increase in new customer loans to £7.9bn, up from £7.5bn at year-end 2016. At the same time, customer deposits also grew by 5%, taking the value of customer deposits held at the bank to £7bn, up from £6.7bn at the end of the last quarter. The group’s net interest margin (NIM), a key measure of banking profitability as it measures the gap between how much interest it is generating on its lending compared to the interest paid out to depositors, remained stable at 3.5%. Even though the NIM did not change during the period, Aldermore’s is still an industry leading-figure as most high street banks are reporting margins below 3%.

As well as the bank’s impressive NIM, its tier one capital ratio stood at a respectable 11.5% at the end of the reporting period. Tangible book value per share rose 5% quarter-on-quarter to 160.3p.

Undervalued growth

Today’s results from the business show that it is on track to hit City forecasts for growth for the year. Analysts are currently expecting the group’s earnings per share to grow by 17% this year followed by a growth of 8% next year. If management can hit these targets, Aldermore will have improved pre-tax profit threefold in just five years. 

However, despite this impressive growth, its shares are trading at a depressed multiple of only 8.8 times forward earnings.  It seems the market is concerned about the bank’s exposure to the UK economy following Brexit. But based on today’s figures, this concern seems unwarranted. Overall, if you’re looking for high-growth at a low price, Aldermore could be a great fit for your portfolio.

Growing wealth 

Wealth manager Rathbone Brothers (LSE: RAT) also announced its first quarter results this morning. Just like Aldermore, it reported strong growth across the business during the first three months with funds under management up by 4.7% to £35.8m. Fee income generated from operations rose 22% year-on-year, reflecting positive markets and growth in business. Commission income also showed a substantial uplift of 12.2% and net operating income for the overall investment management business rose 18.3%.

Rathbone’s growth over the past five years has been nothing short of explosive with pre-tax profits surging 100% from £38.5m to £76.2m as predicted for this year. Over the same period, earnings per share increased by 62%. Analysts are expecting earnings growth of 3% this year followed by 11% for the year after. 

Unfortunately, shares in Rathbone’s are not as cheap as those of Aldermore as they currently trade at a forward P/E of 18.6. Nonetheless, with double-digit earnings rises projected for the years ahead, it looks as if it’s worth paying a premium for the shares.  

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Rupert Hargreaves has no position in any 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.

Virgin Money’s gross mortgage lending increased by 19% in the first nine months of the current year. This resulted in a 3.6% market share of gross mortgage lending to the end of the third quarter of 2016. Net mortgage lending was up 33% versus the first nine months of 2015, with £1.3bn of net mortgage lending in Q3.

In terms of credit card balances, they increased to £2.2bn at the end of September. That’s 41% higher than they were in 2015 and shows that consumer confidence among Virgin customers hasn’t taken a major hit following the EU referendum. And with Virgin commencing a partnership with 10x Future Technologies to build its digital bank, its long-term growth outlook is very positive.

In fact, Virgin Money is expected to grow its bottom line by 34% in the current year, followed by growth of 12% next year. This shows that there’s still considerable scope for challenger banks to muscle in on the under-pressure traditional banking companies. And with this particular challenger trading on a price-to-earnings growth (PEG) ratio of 0.8, it offers excellent value for money as well as a wide margin of safety.

Uncertainty ahead?

Looking ahead, Virgin Money and other challenger banks such as Aldermore (LSE: ALD) could endure an uncertain period. Although Virgin Money’s performance in the third quarter was strong, Article 50 of the Lisbon Treaty to start the Brexit process hasn’t yet been invoked. As a result, there’s still scope for Brexit to have a negative impact on the UK economy and on the banking sector, with negotiations in 2017 likely to provide an uncertain backdrop for the banking sector.

However as mentioned, Virgin Money offers a wide margin of safety so that even if its growth rate does disappoint, its shares may provide capital growth. Similarly, Aldermore is forecast to deliver a rise in earnings of 10% in the current year and 5% next year. While this rate of growth is slower than that of Virgin Money, it’s nevertheless ahead of the wider market’s anticipated growth rate. And with Aldermore having a PEG ratio of 1.3, it offers growth at a very reasonable price.

However, Virgin Money has the greater appeal of the two stocks right now. It’s on track to meet full-year guidance and trades on an ultra-low valuation. Furthermore, it’s focused on building a digital bank that’s likely to broaden the company’s appeal. Alongside a loose monetary policy environment and a UK economy that’s holding up well despite higher uncertainty, Virgin Money has the potential to be a star long-term buy.

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Furthermore, Aldermore was able to record a return on equity of 18%, with its loan origination increasing by 26% to £1.5bn. And with a core tier 1 ratio of 11%, it’s well-placed to overcome the challenges that lie ahead.

UK vulnerabilities

On that topic, Aldermore and other challenger banks such as Shawbrook (LSE: SHAW) face a very uncertain future. Their UK-focus means they’re particularly vulnerable to a UK recession. While this may or may not come to fruition, it now seems almost inevitable that the UK’s economic performance will falter over the next couple of years. The Bank of England is certainly of that view. It recently downgraded the growth outlook for the UK economy in 2017 from 2.3% to 0.8%. This is the biggest downgrade to the growth forecast by the Bank of England since 1992.

Of course, an economic slowdown will bring reduced demand for mortgages and other loans, while increased unemployment will cause default rates to rise. This could impact negatively on the financial performance of Aldermore and Shawbrook, which means that investors may be better off buying a more geographically diversified bank such as HSBC (LSE: HSBA).

Global focus

HSBC operates across the globe and is exceptionally well diversified. Although a UK recession would hurt its financial performance, it wouldn’t be as severe as is the case for Aldermore and Shawbrook.

Clearly, HSBC isn’t risk-free and is undergoing a challenging period as it seeks to rejuvenate its financial performance. As part of this, it’s in the middle of a major cost-cutting and efficiency programme that could expand margins and improve profitability. However, the reality is that in the near term, HSBC’s profit is due to fall by 15% in the current year and as a result, its shares may come under pressure in the near term.

Looking further ahead, HSBC is likely to record strong bottom line-growth. Its exposure to the Asian economy is set to positively catalyse its financial performance since financial product penetration is low and increasing wealth is likely to improve demand for mortgages and other financial services across the region. Furthermore, China is transitioning towards a more consumer-focused economy where credit will be demanded in greater quantity. HSBC is well-placed to capitalise on this.

Therefore, due to its greater diversification and exposure to fast-growing markets, HSBC seems to be a better buy than Shawbrook and Aldermore. It may not be performing as well as those two highly efficient, fast-growing banks right now, but external factors may cause the tables to turn over the medium to long term.

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First-quarter results in March were disappointing, with a 25% drop in pre-tax profits on the back of huge PPI claims, fines in relation to forex rigging and underperformance from the investment banking division.

To make matters worse, Barclays announced that it would be slashing its dividend to just 3p per share for the next two years, in order to conserve capital and absorb losses from toxic assets. That takes the forecast yield to a low 1.64% for next year’s dividend payout.

All in all, it’s not a pretty picture at Barclays, and while there’s a chance that the new CEO may be able to turn things around down the track, there certainly doesn’t seem to be much short-term momentum at the bank.

Challenger banks

If you’re looking for a bank that does have some positive momentum, it might be worth checking out challenger banks Aldermore (LSE: ALD) and OneSavings Bank (LSE: OSB).

Not that you’d know from their share prices, which have both also struggled in the last 12 months.

But to my mind, there’s a clear disconnect between the performance of these banks and their share prices.

Because whereas Barclays is clearly struggling to increase its earnings, both of these challenger banks are enjoying strong earnings growth.

For example, Aldermore reported adjusted earnings per share of 24p for FY2015, up from 18p in FY2014, a rise of 33%. And with city analysts pencilling-in earnings of 26p and 30p for the next two years, this bank definitely appears to be heading in the right direction.

Similarly, OneSavings Bank reported FY2015 earnings of 35p per share, up from 25p in FY2014, a year-on-year increase of 40%. Analysts have earnings per share estimates of 40p and 43p for the next two years.

Yet despite this stellar growth, both of these challenger banks appear to be trading cheaply.

Aldermore trades on a current P/E ratio of 9.5, which drops to just 8.3 on next year’s earnings. And OneSavings Bank’s current P/E ratio is 9.7, dropping to 8.4 on next year’s earnings.

Given that Barclays trades on a P/E ratio of 13.3 times next year’s earnings, the challenger banks certainly appear to offer relative value.

Income investors will be interested to know that while Aldermore doesn’t yet pay a dividend, OneSavings Bank paid out 9p per share in dividends last year, a yield of 2.7% at the current share price. Analysts have forecast dividends of 10p and 12p for the next two years, so there’s potential for dividend growth here.

Of course, the challenger banks aren’t without their own risks.

Both Aldermore and OneSavings Bank specialise in mortgage lending, and with the UK government cracking down on ‘buy-to-let’ mortgages, there’s an element of uncertainty here. Brexit fears are also almost certainly contributing to the recent share price weakness of the challengers.

And given that they’re smaller companies, it’s likely that their shares will be more volatile.

But in my opinion, the challenger banks offer a great risk-to-reward ratio right now. My advice would be to diversify between a handful of challenger banks, in order to reduce company-specific risk.

The post Should you sell Barclays plc and buy Aldermore Group plc or OneSavings Bank plc? appeared first on The Twelfth Magpie.

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Looking ahead, Aldermore is confident of meeting current year guidance, with the bank forecast to increase its bottom line by 14%. And with further growth of 16% pencilled-in for 2016, Aldermore could benefit from an improvement in investor sentiment as low interest rates make borrowing increasingly attractive.

With Aldermore trading on a price-to-earnings-growth (PEG) ratio of just 0.4, it seems to offer excellent value for money as well as a wide margin of safety. As such, it seems to be a worthy buy for the long term.

Bright future

Similarly, financial services peer Standard Chartered (LSE: STAN) also has a bright future. Unlike Aldermore, its recent trading has been very disappointing, with the Asia-focused bank’s bottom line falling into the red in the last financial year. However, with changes to its management team, a more efficient management structure and a renewed focus on compliance, Standard Chartered is expected to bounce back into profitability this year.

While this has the potential to improve investor sentiment in Standard Chartered, what could really excite the market is its growth forecast for next year. That’s because the bank is expected to increase its earnings by 133% in 2017 and with its longer-term future being very bright due to the prospects for increased demand for financial products in Asia, now could be a great time to buy a slice of Standard Chartered. Plus, with it having a PEG ratio of 0.2, it seems to offer a wide margin of safety too.

Fully priced-in

Meanwhile, shares in real estate investment trust (REIT) Tritax Big Box (LSE: BBOX) have risen by 14% in the last year as investors have remained optimistic about the prospects for the wider property sector. Clearly, an improving UK economy is helping to push rents higher and with Tritax Big Box forecast to increase its bottom line by 7% this year and by a further 4% next year, it seems to be performing relatively well.

However, with the company trading on a price-to-earnings (P/E) ratio of 20.3, its growth potential appears to be fully priced-in. As such, further capital gains may be somewhat limited, while Tritax Big Box’s dividends may struggle to rise at a rapid rate since they’re only covered 1.05 times by profit. Therefore, while the REIT sector may have growth potential, there seem to be better options for long-term investors elsewhere.

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This indicates that Lloyds could be due an upward rerating and with the bank having a sound strategy that has improved its efficiency, it seems to be well-placed to deliver a rising share price over the medium-to-long term. That’s especially the case since Lloyds is likely to benefit from an improving UK and global economic outlook that could have a positive effect on its financial performance. And with Lloyds also forecast to increase dividends per share by 21% next year to give a forward yield of 7.6%, its current share price appears to be rather low.

What’s the alternative?

Of course, there are a number of other options within the banking space that may be of interest to investors. After all, Lloyds is forecast to increase its bottom line by just 2% next year, which could fail to sufficiently catalyse investor sentiment in the near term. As such, the likes of Aldermore (LSE: ALD) and OneSavings Bank (LSE: OSB) may be tempting for a number of investors.

A key reason for that is their earnings growth potential. In the case of Aldermore, it’s expected to increase its bottom line by 17% in each of the next two years. This puts it on a price-to-earnings-growth (PEG) ratio of just 0.4, which indicates that its shares could move significantly higher. Similarly, OneSavings Bank is forecast to deliver a rise in its bottom line of 9% this year and a further 12% next year. When this rate of growth is combined with its lowly rating, it equates to a PEG ratio of only 0.6, which is again highly appealing.

Although Aldermore and OneSavings Bank can’t match Lloyds when it comes to dividend yield, in the long run they look set to become impressive income stocks. OneSavings Bank is due to yield 3.6% next year from a dividend set to be covered 3.8 times by profit. Meanwhile, Aldermore is expected to commence dividends next year and although it’s due to yield just 1.8%, a payout ratio of just 12% shows that dividends could rise at a rapid rate.

As such, both OneSavings Bank and Aldermore appear to offer a potent mix of income, growth and value potential. While Lloyds is unable to match them on the growth aspect at the present time, its larger size and greater diversity appears to adequately make up for this. Therefore, even though Aldermore and OneSavings Bank appear to be well-worth buying, Lloyds seems to have sufficient potential rewards on offer, plus lower risks, to give a more enticing risk/reward ratio for long-term investors.

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In the case of Barclays (LSE: BARC), it has the potential to more than double within five years. A key reason for this is its ultra-low valuation. For example, it trades on a price to earnings (P/E) ratio of just 10, which indicates that there is significant upward rerating potential. In fact, if Barclays were to trade on the same P/E ratio as the FTSE 100 of around 14, it would mean that its shares rise by 40% from their current level.

In addition, Barclays is also forecast to increase its bottom line by 19% next year. So, even if its earnings growth rate reverts to that of the wider index (i.e. mid to high single digit per annum)  in the following four years, it would still mean that the bank’s net profit would be around 56% higher by the end of 2020, assuming a 7% earnings growth rate. This, plus the aforementioned upward re-rating potential, would be sufficient for Barclays’ shares to more than double within five years, with dividends boosting its total return yet further.

Similarly, challenger bank Aldermore (LSE: ALD) could also post 100% total returns within the same timeframe. Like Barclays, it trades at a large discount to the FTSE 100, with its shares having a P/E ratio of just 12.3. As a result, there is scope for an upward re-rating and if they were to trade at the same valuation as the wider index, it would mean Aldermore’s shares being priced around 14% higher.

Furthermore, Aldermore is forecast to increase its bottom line by 18% next year and, since it is a challenger bank, it may be more likely to maintain a higher rate of growth in the following years than will Barclays. That’s especially relevant, since the loose monetary policy which has benefitted Aldermore and other challenger banks through increasing demand for new loans is set to remain in place over the medium term.

As a result, if Aldermore can maintain a double-digit earnings growth rate from 2017 through to 2020 then its earnings per share would reach 37.6p. When multiplied by a rating of 14, this would equate to a share price of 526p, which would represent a doubling from its present price level.

Meanwhile, interdealer broker ICAP (LSE: IAP) also has excellent long term growth potential. It trades on a price to earnings growth (PEG) ratio of just 1.3, which indicates that its shares offer strong growth prospects at a very reasonable price.

However, unlike Barclays and Aldermore, there is a lack of upward re-rating potential, since ICAP has a P/E ratio of 15.9. And, while its bottom line is set to rise by 10% next year, even if such a rate of growth is maintained in the next five years it would equate to a rise of only 61% in value, assuming ICAP maintains its present premium rating.

Looking at the company’s track record, though, profit has fallen in two of the last five years. This indicates that five years of double-digit growth may be unlikely and, while ICAP has a 4.7% yield which could contribute 26% in returns over five years, the prospect of a 100% total return by the end of 2020 appears to be rather slimmer than for Barclays or Aldermore.

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Shares in Aldermore Group (LSE: ALD) soared by 8.6% to 302 pence today, as the lender reported better than expected interim results. Underlying pre-tax profits more than doubled, having risen 109% to £44 million in the first half of 2015. The small and medium business-focussed lender saw a rapid expansion in its loan book and an improvement in most of its financial ratios.

Its net interest margin widened from 3.3% last year, to 3.6%, and its cost efficiency ratio improved by 11 percentage points to 53%. Its IPO in March this year has strengthened its capital position, and has allowed Aldermore to increase the rate of new loan originations.

Looking ahead, whilst analysts expect economic conditions are expected to be relatively robust in the UK, the lender faces some headwinds in the medium term. Management warned that there could be an increase in competition in the sector, as a number of new entrants have targeted the undertapped small and business lending market.

Aldermore is heavily exposed to mortgage lending, with mortgage lending accounting for more than 70% of its loan book. In addition, more than a majority of those mortgages are buy-to-let loans, which could suffer from the recently announced reductions to mortgage tax relief for higher rate taxpayers. Furthermore, house prices in the UK have been rising at the slowest rate in two years, and there are concerns that the housing recovery is slowing down.

To fund the reductions in the UK’s bank levy, the Chancellor George Osborne had introduced an 8% surcharge on banking profits, which would take effect from 1 January 2016. But, unlike the bank levy, which was primarily paid by all but the largest financial institution, substantially all banks will be liable to the new banking profits surcharge.

Amec Foster Wheeler

Challenging oil and gas conditions continue to affect Amec Foster Wheeler (LSE: AMFW). Underlying revenues fell by 4% to £2.58 billion and underlying trading profit fell 24% to £188 million in the first half of 2015. But, the company did benefit from the strong US dollar, which is expected to have the effect of lifting revenues by around £50 million in 2015.

Unlike, many other oil service providers, Amec benefits from greater diversification. Demand from markets in downstream oil & gas, petrochemicals and clean energy continue to be robust, and Amec benefits from an order book of £6.6 billion. So, although earnings will likely be much weaker in the medium term, Amec will outperform many of its peers.

Lamprell

Onshore oil services company Lamprell (LSE: LAM) disappointed investors with much weaker revenues in the first half of 2015. Revenues had almost halved to $351.4 million, from $632.3 million last year, but this was partly due to phasing of construction activity. Underlying profits more than halved to $20.3 million, down from $46.1 million last year.

Low oil prices is forcing oil producers to cut their growth capital expenditure budgets, and this is beginning to take their toll on oil services sector. “These challenging market conditions are now expected to last longer than originally envisaged by the industry”, warned Chairman John Kennedy.

Although Lamprell’s earnings outlook is pessimistic, the company has a strong balance sheet and has made great effort to improve its cost efficiency. Looking forward, Lamprell should benefit from its exposure to the Middle East, because low production costs there has meant investment activity has remained relatively robust. So, although conditions are bad, it does seem that Lamprell is doing better than many of its peers.

The post Should You Buy Aldermore Group plc, Amec Foster Wheeler plc And Lamprell plc On Today’s Results? appeared first on The Twelfth Magpie.

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Jack Tang has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.