Investment View: Barclays is in a better place than might be expected

There is no timescale on the payout number: it's an 'aspiration' that might never happen
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The Independent Online


Our view Speculative buy

Price 319p (-7p)

The reaction among investors to Antony Jenkins' new strategy for Barclays was an unequivocal hooray. It seemed as if the bank's shares were on the rise almost from the moment Mr Jenkins opened his mouth. Should we join the stampede? Up to a point.

We've heard the good: Mr Jenkins has pledged that in future the pendulum should swing back from bankers towards the investors who put their money at risk to fund their activities. Compensation ratios at the important investment banking division, he has said, will ease down to the mid-30s. Dividend payments will move in the opposite direction, until the bank is at a point where 30 per cent of earnings are distributed. So far so good.

But there is no timescale on when the bank's payout will hit that magic number: it's an "aspiration" that might never happen.

Loss-making activities in Europe, where the bank has for too long been trying to sustain a second-tier business, will be closed. And here's where the first worry emerges: the bank wants to focus on Europe's "mass affluent" from here on out. Just about every bank in the world wants that sort of business. Which means limited returns.

There's no downside to the bank's pulling out from investment banking in the domestic Asian market – lots of banks out there are competing not for business but for staff. And they are paying through the nose. So the bankers win at the expense of investors.

The wider change this signals is, hopefully, an end to "empire building" for the sake of it.

Some big risks remain. The City has been cheering Mr Jenkins, but what happens if the institutional investors who have been calling for change feel they can go to sleep? Does this leave room for backsliding? Quite possibly.

Then there are the recalcitrant US investment bankers who've been growling about Mr Jenkins. Remember, much of the US franchise comes from Lehman Brothers. The legacy of its debased culture could still poison Barclays.

That said, even after their recent rises the shares are not exactly overpriced, particularly if Mr Jenkins manages to reduce costs as promised (notably in the investment bank) and generate returns on equity that exceed Barclays' cost of capital (this has been promised). In other words, if he improves Barclays' profitability.

Before Mr Jenkins' big announcement Investec had the shares trading on about 80 per cent of net asset value. It's now more like 90 per cent, putting the bank ahead of RBS and reducing the discount to Lloyds.

But arguably it should trade at a substantial premium to the latter. Remember, Lloyds is basically a domestic UK play and the UK economy isn't particularly cheerful. And at the moment, you're not getting any dividend at all. Pay out 30 per cent of earnings? Lloyds needs to sustainably generate some earnings first.

As for RBS, well, it's loss making. Chief executive Stephen Hester admits that there's a long way to go before he's finished his turnaround job. Will what remains be capable of matching Barclays when it comes to growth? Highly doubtful.

Barclays has international exposure, several businesses that look like they have the potential to provide more growth than its rivals can offer, and the potential to out-compete them at home, given that both still have significant issues to deal with and less room for manoeuvre.

I also like its African business, which could prove to be a big strength of the future.

I know I advised pulling the plug in the wake of the Libor scandal, and the shares have doubled from the low they reached during those dark days. But I make no apology – Barclays is still a work in progress, although it is in a better place than I would have expected.

It has taken the right decisions to force changes at the top, and, crucially, to try to repair relations with a slew of interested parties that were strained almost to breaking point under Bob Diamond.

There remain some big risks with this stock, largely from the past: we don't know if all the skeletons in its cupboard have been aired.

I think Barclays can outperform from an investment standpoint. But be alive to the risk. That's why I would add the term "speculative" to today's buy recommendation.