Interactive Investor

Best and worst UK bank shares

23rd April 2015 13:25

Lee Wild from interactive investor

UK banks begin reporting their first quarter results next week. There's a feeling among some in the City that operating conditions have been favourable during the three months. Yet the sector has underperformed against both its European peers and the market, leaving British lenders looking cheap.

Despite the equity market rally, bank discount valuations, and a significant economic recovery, UK bank shares have been significantly outperformed by gilts over the past 12 months. However, the team at Deutsche Bank believe that better markets income and smaller below the line charges helped stated returns and capital-build during the first quarter.

"But, given the UK election and level of the overall market, we expect investors to remain selective - even the US banks which reported better-than-expected results have struggled to break out," write analysts Jason Napier and David Lock in a 43-page note. "Lloyds is our top pick, Barclays offers material valuation upside, Standard Chartered is a Sell. HSBC and RBS are Holds."

"Our preference for Barclays over HSBC and RBS is driven by deep P/E discount and decent deleveraging backdrop. The market discounts applied to Barclays' IB [investment banking] and Non-Core divisions are much too large, in our view."

Barclays trades on less than 9 times 2016 EPS forecasts, just 7.6 times core earnings, and at 0.9 times tangible net asset value for a 10% forward return on tangible equity. 'Buy', says Deutsche, with 310p price target.

Elsewhere, the broker expects capital to strengthen at all banks, but likes Lloyds (Buy, 94p target) for the income potential. "Progress towards strong payouts will look more and more convincing," it says, predicting a 3p dividend and a 3.8% current year yield.

Greater confidence on legacy issues and strategy is key for HSBC (Hold, 570p). Results are out on 5 May, ahead of a further update on 9 June. For now, and despite a 5.6% yield, Deutsche needs more convincing.

Aggressive valuation multiples mean a 'hold' rating and 390p price target remain appropriate for RBS (Hold, 395p). "We expect strong capital build and low provisions for redress and legacy matters at RBS," says Deutsche, but the shares already trade on a lofty 18 times 2016 adjusted EPS, and 13 times 2017 estimates.

Expect better quarterly numbers from Standard Chartered - under new leadership from June - but the shares are still a 'sell' at Deutsche on a six-twelve month view with 865p target. "We expect consensus EPS will fall on capital reallocation, equity raise and dividend cut. The BoE stress test scenario is toughest for SC and we think the move to a sharper business mix must accelerate to maximise shareholder value."

Other thoughts

While the risk of a break-up of Lloyds or Royal Bank of Scotland appears to have lessened following the publication of party manifestos, Labour proposals for a higher bank levy and bank-only bonus tax are important, argues Deutsche.

It thinks Labour's more aggressive position on the banks is most negative for HSBC and Barclays, although all lenders would suffer. Lloyds is best positioned for the change.

Watch out this year's stress test winners and losers, too. "We think it straightforward and demonstrable that Lloyds is best and StanChart worst positioned for this year's stress scenario."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.