Cube Midcap Report (Thur 24 Oct) – Last blast PPI hits profits at #RBS #AJB #POLY

Cube Midcap Report (Thur 24 Oct) – Last blast PPI hits profits at #RBS #AJB #POLY

Good morning, it’s Roland here with the Midcap report.

There’s plenty to choose from in the RNS feed this morning. On my list for today are:

  • Royal Bank of Scotland (RBS) – the RBS share price is down slightly this morning, after it reported punishing PPI provisions in its Q3 figures. I hold.
  • AJ Bell (AJB) – Andy Bell’s investment platform has issued a strong year-end update.
  • Polymetal International (POLY) – the gold bull market continues. Russia-focused POLY has upgraded its production guidance for this year.

I hope to complete the report by about noon 12.30.

Royal Bank of Scotland Group (RBS)

  • Share price: 228p (-2%)
  • Market cap: £27.6bn

Q3 trading update

At the time of writing, I have a long position in RBS.


An unprecedented blast of marketing and publicity created a last-minute surge in PPI claims over the summer. Amazingly, this banking scandal has now cost UK banks more than £50bn.

Most of the big high street banks flagged up this late rise in claims in early September.

Today’s third-quarter results from RBS provide more clarity on the outcome for this bank, in which the government still has a majority stake. In September, RBS expected to increase provisions for PPI by “£600 million to £900 million” in Q3. The actual provision, reported today, is £900m — at the very top of this range.

Not great news. But it’s not really a surprise and is pretty much history now. As a shareholder, I’m more interested in the bank’s continuing performance.

Bond markets nuke investment profits

There was more bad news in today’s Q3 figures. The bank’s Natwest Markets investment banking arm reported a Q3 loss of £20m, down from a Q2 profit of £87m.

The big casualty was income from the Rates business, which provides interest rate products such as swaps. Rates income fell by 44% to £184m due to higher hedging costs, lower bond yields and weaker sentiment on the global economy.

Lending growth

There was better news on the high street, where net loans to customers rose by £0.5bn versus Q2. This was mainly due to a strong increase in gross new mortgage lending, which rose by £1.9bn to £8.6bn during the quarter.

From this I guess we can assume that the housing market is still in relatively good health, with borrowers keen to take advantage of ultra-low rates. The bank took a 12% share of new lending in the quarter, supporting an overall market share of about 10%.

Lending to corporate customers rose too, but may be slowing. Commercial net lending rose by £0.1bn during the quarter, versus a year-to-date growth figure of £1.6bn. At face value, this seems suggests that lending to business customers has slowed dramatically in recent months.

My view

I’m happy to ignore PPI on the basis that no new claims can be made. On this basis, the bank’s underlying return on tangible equity for Q3 was 7%. That’s a slight reduction from 7.5% in H1.

Looking at profitability a different way, RBS reports a net interest margin (excluding NatWest Markets) of 1.97% for Q3, down from 2.02% in Q2. I suspect this reflects tough competition in the mortgage market.

To put these figures in context, Lloyds — which I’d see as a market leader — reported a return on tangible equity of 11.5% in H1 and a net interest margin of 2.9%.

RBS clearly has some way to go to reach the level of profitability and cash generation enjoyed by Lloyds. But the Edinburgh-based group has come a long way over the last couple of years — it’s now profitable and paying worthwhile dividends.

The balance sheet continues to look strong, with a CET1 ratio of 15.7%. Costs are gradually being eroded, too, although the nine-month cost: income ratio of 67.5% remains significantly higher than Lloyds’ H1 figure of 45.9%.

RBS stock trades at a discount of about 16% to its tangible net asset value of 272p after today’s results. With new CEO Alison Rose due to start work shortly, I see this as work in progress and remain happy to hold for income and a long-term recovery.

AJ Bell (AJB)

  • Share price: 380p (+2%)
  • Market cap: £1.55bn

Year-end trading update

Investment platform AJ Bell (which operates the website) must rate as one of last year’s top IPOs. The AJ Bell share price has risen by about 70% since last year’s flotation:

AJ Bell share price chart

Source: Google Finance

Neil Woodford was unlucky enough to sell his stake in AJ Bell shortly before the firm’s flotation. But given the events surrounding Woodford Funds in recent weeks, AJ Bell shareholders will probably be glad that their firm was not such an ardent fan of Woodford as larger rival Hargreaves Lansdown.

As I wrote recently, Hargreaves still seems to be winning new business. Some commentators are predicting greater fallout when the liquidition of the WEIF completes. I’m not sure. I feel that customers are likely to stay put, but we could see some pressure on margins.

In any case, AJ Bell looks a cleaner and safer option at the moment. In today’s year-end update, the company reported a 19% rise in platform customers to 218,169. Assets under administration have risen by 16% to £44.9bn over the year to 30 September, despite a 2% fall in the FTSE All-Share Index over the same period.

However, it’s notable that three-quarters of the group’s AUA comes from its advisory business (, not the direct-to-consumer arm:

AJB FY19 year-end summary

My view

AJ Bell’s growth and financial performance look impressive to me. The group boasts an operating margin of more than 30% and generated a return on capital employed of 42% last year, according to Stockopedia figures.

However, it’s worth noting that so far, Hargreaves Lansdown remains far more profitable. The larger firm’s operating margin and ROCE are both in the mid-60s%. Whether this will be sustainable is debatable.

Although I like AJ Bell, I can’t get excited by the stock at its current valuation. Although earnings are expected to rise by about 25% this year and by a further 20% in FY20, that still leaves the stock on a 2020 forecast price/earnings ratio of 40. That seems high enough to me.

I intend to remain on the sidelines unless a better opportunity emerges.


Polymetal International (POLY)

  • Share price: 1,201p (+1.4%)
  • Market cap: £5.6bn

Q3 production update

I’m not really a gold bug, but if/when I do invest in gold, my choice is normally to buy shares in dividend-paying gold miners.

At £5.6bn, Polymetal International is the largest gold miner listed on the London market following the de-listing of Randgold Resources.

Although I don’t rate POLY has highly as Randgold, it does seem to be a decent business. The group, which operates in Russia and Kazakhstan, generated an operating margin of almost 30% on sales of $1.7bn last year. It’s reported similar performances each year since 2014.

Cash costs are low, at under $700 per ounce. The last-reported all-in sustaining costs of $904 per ounce also looks competitive against a gold price of c.$1,400/oz.

However, borrowings are higher than I’d like to see at this point in the cycle, with net debt of about $1.7bn (1.9x EBITDA at H1 period end). Management are targeting a reduction to 1.5x EBITDA, but I would like to see this enjoy greater priority versus dividend growth.

In any case, this year’s results are expected to benefit from the gold bull market, which has seen the gold price rise by 24% over the last 12 months.

Ahead of today’s news, Polymetal’s underlying earnings were expected to rise by 15% this year. This growth figure may now be slightly higher, because production is expected to be ahead of previous guidance.

Apparently, the Kyzyl Mine in Kazakhstan is performing ahead of expectations. A new concentrator is achieving stable throughput of 2.0 Mtpa, which management say is 11% above its original design capacity.

Production is now “likely” to exceed previous guidance of 1,550 Koz by up to 50 Koz, or about 3.2%. That’s not a big increase, but I guess it’s worth having, especially as higher royalty payments are said to be offsetting some of the gains from higher gold prices.

My view

I’m not inclined to buy gold stocks at current levels. Although POLY’s valuation looks reasonable, with a 2020 forecast P/E of 11 and 4.8% yield, this is presumably predicated on continued bullish conditions for the yellow metal and an absence of problems.

I don’t expect a big change to broker forecasts after today’s news, but if I held the shares I would be happy to continue doing so.

Update 24/10/19 @1400: Following some reader feedback I thought I’d expand this section slightly to take a more critical look at Polymetal’s valuation.

It’s worth remembering that the cyclicality of mining stocks (where profitability depends on commodity prices) means that P/E ratios can be misleading. Quite often, miners look cheapest at a market peak, when they’re enjoying exceptional profits.

One problem is that some mining costs are capitalised and not booked as operating costs. A second problem is that focusing on earnings doesn’t provide the full picture — future/past capex needed to sustain production may not be included.

To get a broader picture, I tend to focus on gold miners’ all-in sustaining costs, which includes costs such as stripping and other sustaining capex. I reference this above.

Another useful metric is simply to focus on free cash flow. Polymetal’s free cash flow is much lower than its earnings. Using the firm’s own figures, free cash flow for the 12 months to 30 June was $175m, compared to underlying net earnings of $333m.

This gives the shares a price/free cash flow ratio of 40, versus a statutory price/earnings ratio of 21.

The difference is stark and tends to confirm my view that Polymetal is a) valued for high gold prices and b) fully valued.

In conclusion, I don’t see any particular reason for gold to continue rising (although it may do so). As such, I’d prefer a greater margin of safety for a new investment in Polymetal, especially given its exposure to Russia.

Once again, I’ll be staying on the sidelines for now.

That’s all for today, thanks for your company.

I’ll be back tomorrow with more Midcap news.



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Wordpress (4)
  • comment-avatar

    For gold I would go Pre Production at the moment . Kefi is cheap just now and near (ish) production.

    • comment-avatar

      Pre production can be dangerous, due to CAPEX blow outs etc. A lot of gold mining companies are either overbudget, overtime or both. Kefi has been seriously delayed just getting to this point, do you believe Harry can get the mine built on time and under budget.

      On the flipside development pre production companies usually go through a re-rate period before commissioning. If you can time it well then its great, but again tread carefully and its only a trade at best. There have been studies done on this…….

    • comment-avatar

      These days I prefer the security of profitable, dividend-paying production when I invest in miners.

      Investing pre-production requires expert knowledge and careful timing, in my view. Without specialising, I don’t feel I have the time/bandwidth to do a competent job with such stocks.


  • comment-avatar

    Thanks for the writeup

    Just want to stress that although AISC is better then the previous cash costs measure which mining companies touted. AISC still tends to exclude certain items i.e interest on debt, taxes etc…. again I’ve seen examples of AISC looking ok, but the company losing money or making a lot less then expected based on AISC numbers. So have to be careful with that too. Cashflow statements I’ve found are the safest way to see what’s happening overall for producers. Off course with mining companies, sometimes orebodies go through difficult transition periods etc…, so sometimes a year can be really good, and the following year terrible as a one off but that then requires knowledge of the geology/engineering aspects itself which is less predictable for us retail investors.

    Mining companies are always finding new ways to trick retail investors. Extreme cynicism has been the way I’ve navigated speculating in this otherwise BS sector.

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