The last fortnight has been brutal for most global financial institutions. Both Merrill Lynch and Citigroup have ousted their CEOs in the face of sub-prime losses, while the European banking sector has dived by 10% in a month alone and now trades on an average 2007 p/e of less than nine, with a dividend yield of 6.5%. Investor concern is twofold. Firstly, quantifying the industry’s losses, and secondly identifying where the “dead bodies” lie.
Turkey of the week: Buy Standard Chartered (STAN), says Merrill Lynch
The last fortnight has been brutal for most global financial institutions. Both Merrill Lynch and Citigroup have ousted their CEOs in the face of sub-prime losses, while the European banking sector has dived by 10% in a month alone and now trades on an average 2007 p/e of less than nine, with a dividend yield of 6.5%. Investor concern is twofold. Firstly, quantifying the industry’s losses, and secondly identifying where the “dead bodies” lie.
Over the past couple of years many toxic loans have been repackaged and sold on by their original lenders across the world – with analysts reckoning that total bad debts could reach $250bn (£125bn) in the US alone. If correct, then inevitably more banks will release profits warnings in the coming months, which could hit dividends as capital adequacy ratios become stretched.
So why is Standard Chartered trading on a 2007 p/e ratio of over 17 – 50% higher than its peers? It looks like flimsy takeover speculation, rather than fundamental economics. ICBC, China’s biggest bank, recently bought 20% of South Africa’s Standard Bank and the China Development Bank has spent £1.5bn on a 3.1% stake in Barclays – so now speculators are assuming Standard Chartered will be the next predatory victim. This is possible, but I can’t see it happening at these lofty price levels. The synergies required to make any deal work (say with a 30% control premium) would be colossal. And if consolidation does occur in the sector, then surely any rational buyer would seek out far cheaper targets than Standard Chartered.
Standard Chartered is well placed to continue its strong organic growth, as it is focused on the emerging markets of Asia, Africa and the Middle East, where it derives 90% of its profits. But note that countries such as China, Singapore and India will suffer as the US economy slows. There are also other risks that could impede Standard Chartered’s future performance – including a hike in emerging-market risk premiums, perhaps as a result of geopolitical uncertainty in the Middle East or Pakistan. Bad debts also rose 3% to $361m in the first half, while the cost-to-income ratio deteriorated 1.1% to a worrying 54.7%. Finally, with its earnings primarily in US dollar-related currencies, an adverse shift in currency rates would hit forecasts. Standard Chartered’s dividend yield is thin at 2.3% and the stock trades at a hefty 2.8 times net assets.
This frankly looks too rich, especially when compared to the firm’s larger peers, such as HSBC, which trade on corresponding ratios of 4.8% and 1.9, and Royal Bank of Scotland on 7% and 1.1. In this highly volatile sector I would value Standard Chartered on a 13 times p/e multiple or around £12.80 per share.
Recommendation: TAKE PROFITS at 1,722p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments