Impressive growth

Aldermore, which only started trading in 2009, is certainly showing impressive growth in its balance sheet. In the six months to 30 June, its loan book grew by 8% to £8.1bn, as new loan originations gained 10% on the same period last year, to £1.6bn. This brings it closer to meeting its targeted growth range of 10%-15% for its year-end loan book.

As a result, profit before tax rose 32% to £78m, while basic earnings per share grew by 45% to 14.9p.

Aldermore also said its loan losses this year would be at the lower end of medium-term guidance of between 25-35 basis points due to benign credit conditions, reflecting the group’s prudent underwriting standards and continued resilience in the UK labour market.

Value play

At its current share price of 228p, Aldermore still trades at just 7.5 times its expected earnings this year, with City analysts projecting bottom-line growth of 21% in 2017. That makes the stock seem to me like an attractive value play, but I also think it’s worth considering some of the limitations of this business.

While it looks set to grow robustly in the near term, its longer-term prospects seem more uncertain. I have doubts about whether Aldermore’s business model can sustain double-digit earnings growth as the economy slows.

I fear its over-reliance on mortgage lending, which currently accounts for more than three-quarters of its loan book, and worry about waning momentum in the UK housing market, which would likely put pressure on earnings growth going forward.

Although I think Aldermore is a well-run bank with a profitable and efficient operating model, I reckon there may be safer growth and income opportunities elsewhere.

Lloyds

Its much bigger rival Lloyds Banking Group (LSE: LLOY) seems to me like a better pick. It has less relative exposure to the more risky buy-to-let mortgage market, and as a mainstream lender, it has a more diversified loan book, which reduces its credit risk.

Having said that, Lloyds’ recent growth has been slower, with underlying profits in the first half up by a less impressive growth rate of 8%, to £4.5bn. The bank also booked another £1bn provision for conduct charges in the second quarter, primarily in respect of PPI.

However, with the PPI deadline looming, it looks set to grow its already strong capital generation. With a common equity tier 1 (CET1) ratio of 14%, Lloyds has a robust balance sheet, which means any surplus capital should lead to growing dividend payouts for shareholders.

Combined with steady earnings growth, City analysts reckon shares in Lloyds are set to yield 5.8% this year, rising to 6.5% in 2018. The bank also trades at a forward P/E of 9.1, as underlying earnings is forecast to grow 8% this year.

The post Better buy: Lloyds Banking Group plc vs Aldermore Group plc appeared first on The Twelfth Magpie.

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Jack Tang has a position in Lloyds Banking Group plc. The Motley Fool UK has recommended Lloyds Banking Group. 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.

Now, this return to profitability doesn’t mean CYBG is a clear cut buy, but it does signal that the bank is in a far, far better position than its larger Scottish rival. Why? Three reasons: operating costs, restructuring efforts and growth opportunities.  

RBS’s struggle to tame high operating costs is nothing new to investors. In the three quarters to September the bank’s cost-to-income ratio was 94%. To be fair, this is an improvement on the 101% posted in the same period the year prior. Yet it remains both higher than CYBG’s and is improving at a slower pace. From 2015 to 2016 CYBG’s cost-to-income ratio fell from 120% to 88%.

There are a variety of reasons for this, including RBS’s unwanted legacy divisions, higher IT costs and stricter regulatory compliance issues. However, the crux of the matter is that it’s much easier for CYBG to cut costs due to its much smaller size. In 2016 CYBG averaged 6,700 full time employees while RBS has averaged 82,500. With fewer employees and branches, CYBG has a much clearer and more viable path to slimming down operations.

Indeed, CYBG has been able to bring forward ambitious return on equity (RoE) and cost-to-income targets from 2020 to 2019. Meanwhile, RBS was forced in Q3 to admit that it will fail to reach its own cost-cutting targets for 2019. These diverging outlooks for future profitability don’t bode well for RBS.

The RBS issue

With shares still stuck well below their pre-Financial Crisis peak it’s easy to forget that RBS was, for a very brief moment in 2008, the world’s largest bank. But, the sheer size of those globe-spanning assets helps explain why the current management team is still deeply mired in restructuring efforts eight years later.

The Sisyphean complexity, and cost, of these tasks is very clear when we look at RBS’s income sheet. In Q3 alone the bank was forced to depart with £469m related to these efforts while CYBG’s relatively healthier asset base forced only £45m in restructuring expenses in the whole of fiscal year 2016. RBS is slowly but surely spending less and less on this turnaround, but few analysts are expecting it to be completed for several years.

CYBG also bests RBS in growth potential due to its smaller size. Thus far, constrained to Yorkshire and Scotland, CYBG is currently in talks with RBS to purchase the Williams & Glyn branches that regulators have demanded be sold. Buying these 300 odd branches would both broaden CYBG’s geographic exposure and more than double the bank’s branch numbers.

Finally, and perhaps most importantly for investors attracted to banks for their income potential, CYBG has declared 2017 as the year dividends begin. Analysts are penciling-in a small 0.9% yield in the first year, but management has confirmed 50% of earnings will be paid out in the future. RBS, of course, has yet to return to dividend payments and isn’t going to for a long time yet.

The post Challenger bank CYBG plc’s first profit makes it a better buy than RBS appeared first on The Twelfth Magpie.

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Good growth potential 

At first glance, outsourcing group Capita (LSE: CPI) seems incredibly cheap. The stock trades at a P/E of just 8.0 and has a price-to-sales (P/S) ratio of 0.8. But are these valuation metrics deceptive in light of the group’s recent profit warning?

Back in September, Capita warned that its pre-tax profit may fall short of its earlier estimates following delays to its contract with the Transport for London (TfL), which is expected to cost the company a one-off charge of between £20m and £25m. It now expects to deliver underlying pre-tax profits in the range of £535m to £555m, which is up to 15% below its earlier projections of £614m.

Shares in the company have since fallen by about 42%, but have investors overreacted? Captia’s earnings will certainty hit a bump this year, but the company is expected to return to growth thereafter. The company maintains good growth potential and is not being complacent. It has won £949m worth of new contracts so far this year, and has announced plans to simplify its organisational and management structure.

Capita said the revamped structure would “provide greater management strength and depth across all of Capita’s operations” and “provide a deeper sales and business development focus and greater support in driving organic growth“.

City analysts have lowered their expectations for earnings in recent weeks, but earnings forecasts are still pointing towards a modest rebound for the following year. Underlying EPS is expected to fall by 7% this year, but increase by 4% in 2017. This means its forward P/E is expected to fall to 8.4 in 2017, from 8.7 forecast for this year.

And despite its recent troubles, the company is expected to maintain its progressive dividend policy. That’s because even as earnings is projected to fall this year, earnings is set to cover its dividends by more than two times. Investors should, therefore, have little to worry about the sustainability of Capita’s 5.6% dividend yield.

Lagged the market

Another growth stock looking too cheap to ignore is specialist lender OneSavings Bank (LSE: OSB). The stock was one of the top performers in the sector back in 2014 and 2015, but it has since lagged the market, after having fallen by more than 12% year-to-date.

But with city analysts expecting the bank to deliver earnings growth of 14% and 3% for 2016 and 2017, respectively, I reckon the stock is oversold. Based on these estimates, OneSavings Bank is valued at 7.1 times expected earnings this year, and 6.9 times its earnings in 2017.

There are downside risks though. The bank is heavily exposed to the buy-to-let mortgage sector, which is highly cyclical and more vulnerable to interest rate hikes. The economy, which has proved to be more resilient than expected in recent months, is expected to slow in the coming months and this could potentially lead to slowing demand for new mortgages and rising loan impairments.

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Both are domestic-focused retail banks, so it’s not down to Virgin undertaking some risky trading strategy or expanding into high-growth developing markets. The biggest reason as I see it is the considerably different growth prospects for the two banks.

Virgin’s market cap of £1.4bn versus Lloyds’ £39bn illustrates quite clearly how much more room Virgin has to grow than its lumbering rival. We also see the differences in one of the most important business lines for both banks, mortgage lending. While Lloyds originated 25% of all new domestic mortgages last year, Virgin’s market share was only 3.6% in the past half year.

It’s quite obvious then that Virgin will find it much easier to continue growing at a rapid clip while Lloyds’ sheer size will make it hard to grow its already substantial market share for major products.

Going hand-in-hand with top-line revenue growth is Virgin’s ability to rapidly juice profits. This is also a byproduct of its relative size as Virgin has been able to tackle stubbornly high costs at a quicker pace. Over the past half year Virgin was able to bring its cost-to-income ratio down from 68.3% to 58.8% year-on-year. Lloyds, despite embarking on an ambitious cost-cutting scheme was only able to improve from 48.3% to 47.8%.

The reason for Virgin having such high costs is due to its purchase of the former Northern Rock assets from the government in 2011. Cutting the bad bits from these assets has allowed Virgin’s return on tangible equity (RoTE) to catapult from 9.5% to 12.2% year-on-year through the last six months. By comparison, Lloyds’ underlying RoTE in the same period fell from 16.2% to 14%.

Income is key

However, many investors look at banks for income rather than growth. In that regard Lloyds is far ahead of Virgin. As Virgin is still investing heavily in expanding its business, dividend yields at the bank are currently quite low, at only 2%.

On the other hand, Lloyds shares currently provide investors with a very decent 4.3% yield annually. These shareholder returns also have considerable room to grow in the medium term once payments for PPI claims are finally ended. This may be several years away though, so Lloyds is likely to end up shelling out more than the £16bn it already has.

Over the long term though, I believe Virgin Money offers both better growth and dividend prospects, which will undoubtedly play out in its shares continuing to outperform those of Lloyds. Dividends are a function of profits, and if Virgin can continue growing earnings by double-digits while Lloyds’ profits fall then its shareholders will eventually benefit from hefty dividends.

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Solid housing

Housebuilder Bellway (LSE: BWY) was looking very good on a forward P/E of nine with a PEG ratio for this year of 0.3 (where growth investors typically see 0.7 or less as a good sign) — that was when the shares were changing hands at around £27 apiece, and since then they’ve lost 37% to just 1,700p, as fears of a housing collapse grip the City’s traders.

Now, there is a big risk to the UK’s housing market, for sure, at least partly from European investors who will be a lot less keen to risk their money here. But long-term profits for housebuilders do not depend on short-term property prices, and if demand falls, prices will fall and the houses will still be sold — to grateful occupants, I hope.

But that means land prices would fall too, and cash-rich builders like Bellway should be able to top up their land banks at low prices — just as they did during the last financial crisis. Long term, I reckon housebuilders, including Bellway still show great growth potential.

Support woes

Support services group Interserve (LSE: IRV) has had a horrible time, with its shares losing 56% over the past five years — they had been rallying slightly, but have fallen back 15% since Thursday, to 266p. But the firm’s earnings per share have actually been picking up over the past few years, and an expected standstill over the next few years puts the shares on a P/E of only a little over four — and that’s with a forecast dividend yield of 8.6%!

So, why so cheap? Well, after Interserve’s acquisition of Initial last year, its net debt rose to £309m, and that’s a lot for a company with a market cap of £385m and pre-tax profit of just £79.5m. Coupled with some big one-off costs this year, I think there’s a good chance the dividend will be cut,  even though it’s currently reasonably well covered by forecast earnings.

But the current super-low valuation means Interserve could still offer a decent yield, and with the City’s brokers putting out a strong buy rating on the shares, I see good long-term growth potential — even if we could still see another volatile year in the short term.

Banking carnage

You don’t need me to tell you that banking sector shares have collapsed since the referendum, and the short-term uncertainty means there’s no surprise there at all. Lloyds Banking Group shares are down 28% and Barclays are down 31%,  which I think is seriously excessive, but the one really takes the biscuit is Virgin Money (LSE: VM), whose shares are down a massive 42% since the referendum, plummeting to 212p.

Sir Richard Branson had said he expected Virgin shares to “take a pounding” in the event of a ‘leave’ result and that there could be job losses, and the challenger bank does face danger from its focus on mortgage lending should we really see a housing slump. But if the bank can pull through the short-term pressure (and I see no reason why it shouldn’t) then it could have some serious longer-term growth prospects.

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It shouldn’t have come as a surprise as Glencore announced late last year that it was cutting production of copper, zinc, lead, coal and oil in response to low prices — copper output was down 4% on the first quarter of 2015, with zinc down 28% and coal down 17%. But full year guidance remains largely unchanged, with the exception of a 0.3m bbl drop in oil due to reduced exploratory drilling. So are Glencore shares good value now?

With great progress made in debt reduction, commodities prices on the up again, and a return to strong earnings growth on the cards, I think the future is solid — even if Glencore shares are on a short-term high P/E.

Fashion boost

Next (LSE: NXT) shareholders, meanwhile, woke to sunnier news and to see their shares up 4% to 5,180p, despite the clothing chain reporting a 0.2% drop in sales between 31 January and 2 May (and a 0.9% drop in full-price sales). That ‘s at the lower end of the firm’s full-year sales guidance of -1% to +4% — and the company responded by lowering and widening it to a range of -3.5% to +3.5%, with pre-tax profit of between £748m and £852m indicated.

The increasing shift from in-store sales to online sales is also apparent, with full-price Next Retail sales down 4.7% in the period while Next Directory sales climbed by 4.2%.

Even with the small sales fall, the cash just keeps flowing — Next expects to generate £350m of surplus cash in the current year, and has already returned £181m through share buybacks and a special dividend.

Next shares are down 31% so far this year and on a forward P/E of 11, dropping to 10.6 on January 2018 forecasts, and for such a well-managed company that looks like a long-term bargain to me.

Banking upstart

Virgin Money (LSE: VM) shares spiked when the markets opened, but at the time of writing they’re down 2.2% to 346.5p, even though first-quarter mortgage lending came in 30% higher than a year ago, at £2.1bn.

With the bank having just a 3.4% share of the UK’s mortgage lending so far and the Virgin brand seen as a trustworthy one, there’s clearly significantly more scope for expansion than the bigger lenders and we could be in a golden age for the country’s challenger banks. Chief executive Jayne-Anne Gadhia was “delighted to report it has been another excellent quarter for Virgin Money,” and I can understand her enthusiasm.

The share price has been erratic, but since 20 January we’ve seen a 29% rise, and strong EPS growth forecasts suggest a P/E dropping as low as 8.5 by the end of 2017. Virgin Money shares could definitely be worth a punt.

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Slow GDP growth combined with Lloyds’ sheer size (it now has roughly 20% of the UK mortgage market) means it will be difficult for Lloyds to dramatically improve its top line going forward. So, any gains the challenger banks make will likely be at the expense of Lloyds and other high street giants.

This long-term problem as well as the short term issues of continued PPI claims and high operating costs are enough to give me pause on Lloyds. Although analysts are expecting dividend yields to reach 6.5% this year, shares trading at 1.04 times book value with little possibility of dramatic growth make me believe share prices will likely continue to stagnate.

Like a Virgin

Challenger bank Virgin Money (LSE: VM) seems to have no problem growing fast and analysts expect this to continue for some time. Controlling 3.4% of domestic mortgages and 2.5% of the credit card market gives Virgin lots of room for high organic growth.

This high growth potential and proven ability to keep costs low give Virgin quite a leg up on staid competitors such as Lloyds. Return on equity (RoE) in 2015 was 10.9%, which is below Lloyds’ adjusted number, but a massive improvement on the 7.4% put up in 2014 and 2.3% in 2013 after the Northern Rock purchase. Management expects to crank RoE up into the mid-teens by 2017, which combined with significant revenue growth prospects leaves me quite bullish on Virgin Money.

Metro’s march

Metro Bank (LSE: MTRO) may have only gone public in March, but it has already snapped up significant numbers of depositors who are attracted by its customer-friendly approach to banking. Signing up an additional 62,000 customers in the first quarter of 2016 alone helps explain why deposits rose 15% quarter-on-quarter and revenue 11%. This additional revenue helped shrink losses for the period to £7.9m.

If growth continues at this pace, management expects to break even this year and finally turn a profit in 2017, which isn’t bad for a bank started in 2010. However, it’s not all roses for Metro Bank as the company appears to be behind schedule on its proposed branch-opening schedule. With 41 current branches and £5.9bn in deposits, it’s well below its 2020 target of 200 branches and £50bn in deposits. But, given the company’s torrid pace of growth, successful history of the founder’s American bank and large market to disrupt, Metro Bank is certainly higher on my watch list than Lloyds.

The post Should Lloyds Banking Group plc fear upstarts Metro Bank plc & Virgin Money Holdings (UK) plc? appeared first on The Twelfth Magpie.

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Indeed, since the end of 2015 shares in Virgin Money and OneSavings have gained 18.5% and 29.7% respectively, outperforming RBS, Lloyds, HSBC and Barclays (LSE: BARC) by an average of nearly 50% excluding dividends!

And over the past 12 months, the two challengers have continued to outperform peers such as Barclays. Since the end of April last year, Virgin Money has outperformed Barclays by more than 20%, and OneSavings has crushed its larger peer by around 32%.

It looks as if these outstanding performances are set to continue as Barclays struggles to return to growth and keep costs under control.

Set to continue 

Barclays’ shares slumped by as much as 7% at the beginning of March after it published its full-year profits for 2015, which were disappointing to say the least. 

Underlying annual profits for 2015 fell 2% to £5.4bn, and the bank went on to announce a further £1.45bn provision for PPI misselling. Moreover, alongside the results, the group declared that it would cut its dividend by more than half to 3p per share in 2016 and 2017 to save cash, and it is also planning to sell its 62.3% stake in Barclays Africa at some point during the next two years.

City analysts currently expect Barclays’ earnings per share to fall by 4% for 2016 to 16p. Next year, analysts have pencilled-in earnings per share growth of 41%. However, for the past five years, Barclays has consistently missed growth forecasts and failed to report any substantial increase in profitability. Between the end of 2011 and 2015, reported pre-tax profit more than halved and earnings per share have fallen by 9p or 35%. The bank’s shares currently trade at a forward P/E of 11.7.

On the other hand, OneSavings and Virgin Money have both racked up impressive growth rates over the past few years, and City analysts are predicting more of the same ahead.

Explosive growth 

Analysts are currently forecasting that Virgin Money’s earnings per share will be up by 6% for the 12 months to 31 December 2015. For the 12 months to 31 December 2016, earnings per share growth of 40% is expected and for 2017, earnings per share are currently expected to increase by a further 30%. Overall, the City expects that Virgin Money’s earnings per share will grow by nearly 100% over the next two years. The bank’s shares currently trade at a forward P/E of 14.8.

Meanwhile, forecasts suggest OneSavings’ earnings per share will grow 9% this year and 11% for 2017. Since 2013 OneSavings’ pre-tax profit has increased by 237%. The bank’s shares currently trade at a forward P/E of 7.8 and support a dividend yield of 3.1%.

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Great growth in earnings

Underlying pre-tax profit is up 53% since last year, and the firm reports an array of other positive financial outcomes.

Virgin Money’s chief executive says,

“We have performed strongly against our objectives, including delivering market-beating growth in our core mortgages, savings and credit card businesses, maintaining the quality of our balance sheet and delivering a customer satisfaction rating among the highest scoring retail banks in the UK.“

Virgin Money’s business is flying, which is a great result for the UK government. Britain regulates its banks through the Bank of England’s Prudential Regulation Authority (PRA) and one of the PRA’s objectives is to facilitate effective competition in Britain’s banking market. So, seeing a ‘challenger’ bank such as Virgin Money growing like mad will delight regulators and politicians, who seem set on seeing power wrested from the clutches of Britain’s big banks, such as HSBC (LSE: HSBA) and others.

City analysts following Virgin Money expect earnings to shoot up by 33% during 2016 and by 30% in 2017. That’s a cracking rate of growth, which demonstrates the firm is doing a lot right.

A modest valuation?

At today’s 361p share price, the firm’s forward price-to-earnings (P/E) rating runs at just over 11 for 2016, which seems modest for such growth. Perhaps that’s because the recent general market weakness seems to have pulled the share price down. In 2015, the shares traded as high as 450p.

Virgin Money’s growth forecasts contrast with those of HSBC. City analysts see the troubled banking giant achieving a 4% uplift in earnings during 2016 and 9% in 2017.

In February, HSBC’s chief executive said, “The current economic environment is uncertain, but our diversified banking model, low earnings volatility and strong capital generation give us strength and resilience that will stand us in good stead.”

At today’s 471p share price, the firm trades on a forward P/E rating of just below 10 for 2016, which is just a smidgeon below fast-growing Virgin Money’s. Although sporting a large market capitalisation, HSBC seems to be a business aiming to recover from recent challenges, whereas Virgin Money looks like a growth proposition. The valuations seem close, and that makes Virgin Money seem all the more attractive.

Dividend yields

HSBC’s forward dividend yield sits at around 7.6%, with the payout covered about 1.35 times by earnings. At Virgin Money, the yield is just over 1.7% for 2016, and earnings cover the payout more than five times. Such robust cover from earnings reinforces my view that the directors think there is plenty of growth potential left in the business.

I’d rather invest in Virgin Money than HSBC and believe there is a good chance that the firm could trounce total returns available from its larger rival.

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However, as some traders head for the exit, those patient enough to see the bigger picture and sit tight through the volatility can be richly rewarded over the long term. Both in terms of capital and rising income.

Banking on a recovery

I believe that investors that are happy to buy and hold shares in Lloyds Banking Group (LSE: LLOY) could well be laughing all the way to the bank, as management continues to shape this slumbering giant into a UK-focused retail and commercial operation.

While it is true that investors were disappointed with further provisions for past PPI misdemeanours and below-forecast performance in the third quarter, management pointed to a strong balance sheet and liquidity position, with a Common equity tier 1 (CET1) ratio of 13.7% versus 13.3% as at 30 June – that’s a strong position to be in. Additionally, costs continued to shrink towards the 2017 target of 45%

And for the income seekers out there, analysts are pencilling in a well covered 3% plus dividend yield for the year ending 2015, and a twice covered 5% yield to be had in 2016. I’m happy when I’m paid to wait!

Rise of the challenger banks

One thing that management at Lloyds would love to be able to do is start with a clean slate. This is exactly what is happening with two sub-billion market cap challengers. Both Shawbrook (LSE: SHAW) and Aldermore (LSE: ALD) both came to market in the first half of this year. As we can see from the chart, both are easily beating the FTSE 100 and their larger peer.

Shawbrook, a specialist lender and savings bank, has accumulated a near £3bn loan book since it was created in 2011. The Company provides loans to the United Kingdom’s small and medium-sized enterprises and consumers. Its Commercial Mortgages division provides mortgages for residential investors, short-term loans for property professionals and commercial property loans for seasoned investors and owner-occupiers.

Analysts are positive on the stock, with net earnings expected to rise to £60m in 2015 and to over £80m in 2016. This puts the shares on a forecast P/E of just over 11 times earnings. Additionally, the bank is expected to enter the dividend list in 2016, and whilst an expected 1% yield isn’t the best on offer in the market, it should be a good base to start from.

Aldermore Group plc was established in 2009 and focuses on specialist lending to small and medium-sized enterprises (SMEs) and homeowners. The Company’s lending segments include asset finance, invoice finance, SME commercial mortgages and residential mortgages. It is funded through online retail and SME deposits.

As with Shawbrook, the investment community has a positive view of the shares, with analysts steadily upgrading their forecasts over the last twelve months. For the year to 2015 the market is expecting net profit to almost double, then rise by nearly 20% for 2016 — and I wouldn’t be surprised to see this rise further with the UK economy in good shape. While there isn’t a dividend expected till 2017, it could well pay to get in early as there seems to be plenty of growth on offer, which makes it an attractive proposition in my view.

Summing it all up

Here we have three profitable banks, one transforming itself into a leaner lender while dealing with its legacy issues and set to yield over 5% in time, and two smaller peers that look set to grow quickly and start to distribute some of those profits to shareholders via dividends.

The post Why I’d Buy Lloyds Banking Group plc And Less Well Known Shawbrook Group plc and Aldermore Group plc appeared first on The Twelfth Magpie.

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Dave Sullivan 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.