Barclays and HBOS are sound bets

Profile Therapeutics still looks undervalued
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The Independent Online

The FTSE 100's 10 quoted banks account for a fifth of the value of the entire stock market, so your pension fund almost certainly owns them. Familiar high street names, one and all, they are also a solid choice for the private investor.

The FTSE 100's 10 quoted banks account for a fifth of the value of the entire stock market, so your pension fund almost certainly owns them. Familiar high street names, one and all, they are also a solid choice for the private investor.

The sector has been a bulwark against the ravages of the bear market. Shares in the 10 are at the same level as at the end of 1999, when the FTSE 100 peaked, even though the UK market as a whole is down 31 per cent. Add the sector's impressive dividend payouts, and holders of a portfolio of bank shares have done remarkably well.

But the average masks wide variations in performance. A Northern Rock shareholder has made a total return - share price gain plus re-invested dividends - of 70 per cent since the start of 2000. But Abbey National and Lloyds TSB investors have suffered negative returns, partly because the pair own large life insurance businesses where consumer confidence and solvency have come under pressure.

All 10 have now reported back on their financial performance in 2003 and broadly confirmed that the trends of that year have continued into 2004. The UK's famously indebted consumers are still borrowing more. Provisions necessary for bad debts, though, remain low. Competition is ferocious on the high street and profit margins are continuing to erode.

Apart from HSBC and Standard Chartered, which have a focus on the potentially lucrative emerging markets of Asia, most of the sector's shares are valued on multiples of this year's earnings bunched around nine or 10 times. That is cheap overall but it also means that investors are not yet paying up for those domestic banks which are likely to outperform in the coming years.

The exception is Northern Rock, whose Newcastle-based management have been the stars in keeping costs under control. This created a virtuous circle of cheap mortgage deal, more customers and greater benefits of scale... but it also means the shares, on 11.5 times 2004 earnings, have got ahead of themselves and are a sell.

Investors looking for capital growth might want to steer clear of the mortgage banks entirely. We are not predicting a housing market collapse but with all the noise about indebtedness, it is difficult to imagine that borrowing will continue to accelerate over this year as a whole. Alliance & Leicester will remain a buy for income investors, but Bradford & Bingley operates in the riskier niches of self-certification and buy-to-let mortgages and its shares should be avoided.

Another outright sell is Abbey National, whose recent results suggest we were wrong to recommend hanging on to the stock last October. The disposal of its wholesale banking division has got gummed up; the life insurance division needs to be topped up with new capital; and it seems implausible to hope Abbey can raise margins when there is growing pressure to give its existing mortgage customers access to the same cut-price deals as new borrowers.

Vying with Abbey to be most disastrous banking investment of the decade so far is Lloyds TSB but we think the dividend yield makes it a buy. A sprucing up of its offering should enable it to sell more financial products to its customers and set it off down the road to recovery.

Both HSBC and Standard Chartered look expensive, but while HSBC has diluted its focus on emerging markets through the acquisition of Household in the US, Standard Chartered is worth holding for the long term.

Royal Bank of Scotland is also a core holding in the sector, one of the best managed and most ambitious banks, but it is also the UK's biggest credit card lender (through a portfolio of different brands of card) and so is not an outright buy for the time being.

Our top picks are Barclays and HBOS. The former is cheap on a variety of measures and ought to gain as the increasingly confident UK corporate sector borrows funds for new investment. HBOS is much smaller in business banking, but in this area, like most others, it is making the running in price competition and taking market share as a result.

Profile Therapeutics still looks undervalued

Profile Therapeutics has developed a novel inhaler. Instead of delivering a more or less random squirt of a drug when a button is pressed, the intelligent device measures how much the user can inhale in each normal breath, and then releases the right dose.

The system works, but just what exactly will it be best used for? The company has been a frustratingly long time finding the right drugs to deliver via the system, and the ambitions have been scaled back as the years have passed. Profile's inhaled antibiotic for cystic fibrosis sufferers will be available with the latest version of the inhaler within the next few months - a real milestone - but Profile really needs to attract other drug companies to sign up to use the inhaler, too. US product launches are a couple of years away, and analysts think it is only then that profits can start to roll.

So Profile is a speculative venture, but it is not one guzzling cash. It has husbanded its resources, has £3.3m in the bank and a £5m overdraft facility, and it also has a growing cash-generative business selling run-of-the-mill respiratory devices, where turnover grew 13 per cent in the six months to 31 December. The shares, at 40p, are back where we tipped them going into the midst of the biotech slump in 2002, and they are undervalued still.

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