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Market Report: RBS bucks weak banking sector trend

Royal Bank of Scotland was among the most resilient of the banks last night, standing firm after a broker endorsed the group's strategy of reducing the size and complexity of its business.

As RBS, flat at 52p, looks to pare back, Cazenove said its core businesses were "capable of achieving at least [a] 15 per cent return on equity", an attractive prospect given the backdrop of regulatory uncertainty. Moreover, running off the non-core assets will bring down the cost of short-term wholesale funding, addressing funding issues, and bringing the group's customer loans closer to parity with deposits, the broker explained.

"Management's guidance suggests the core businesses are capable of earnings of 7-9p, while we feel if re-pricing is sustained system-wide, 10p is achievable in buoyant conditions," Cazenove said. "We regard the share price at 52p as discounting management's target for 2013 and yet, in contrast to others in the sector, RBS has adopted a cautious outlook to give grounds to believe that the targets could be exceeded, in our view."

Despite its confidence in the strategy, the broker did scale back its recommendation to "in line" from "outperform", citing the near-term prospect of a share issue.

Save HSBC, which gained 0.8p to 704.2p, the wider sector was weak, as traders watched out for any comments regarding banking regulation from the G20 summit in Pittsburgh. Lloyds was weakest, falling to 103.45p, down 3.4 per cent or 3.65p, while Barclays slipped to 357p, down 2.1 per cent or 7.55p, despite some words of support from Evolution, which reiterated its "buy" stance on the stock.

"For many of the banks we cover, 2009-2010 will be poor years: revenues will be sluggish due to the economic crisis and low rates, and provisions will be a major drag," Evolution said. "But investment banks, and Barclays in particular, will show in 2009-2010 one of the best earnings progressions in our universe."

For those investors worried about the run rate in 2011, the broker added that while it foresaw a small fall in operating profit, it expected underlying earnings to grow by 12 per cent.

Overall, the FTSE 100 closed broadly flat, edging up by 2.93 points to 5082.2. The mid-cap FTSE 250 index proved less resilient, declining to 9060.44, down 32.58 points. The benchmark, although firm at the end of the day, closed off earlier highs as traders looked to Wall Street, where sentiment suffered after it emerged that new orders for long-lasting goods had unexpectedly declined in August, sparking concern about the sustainability of the economic recovery.

Petrofac, down 2.4 per cent or 23.5p at 951.5p, was held back by Goldman Sachs, which switched its stance on the oil services group's stock to "neutral" from "buy" in a new sector review, citing valuation. "The stock is now trading at a significant premium to the rest of the sector, and while we continue to see opportunities for the company to grow backlog, we believe that the rate of growth ... may have to slow given that it has more than doubled in the last nine months," Goldman said, raising its target price to 1585p from 1180p, but leaving its earnings estimates unchanged.

Bank of America Merrill Lynch also weighed in, moving Petrofac to "underperform" from "neutral". "We believe that the stock is at the stage that it is priced for perfection, offering no room for disappointment," Merrill said, sticking to its 930p target.

Wood Group, which was moved to "neutral" from "conviction buy" at Goldman, was 1.5 per cent or 4.7p weaker at 300.5p, while Soco International, which was upped to "buy" from "neutral" at Goldman, climbed to 1402p, up 2.1 per cent or 29p. "In the longer term, we believe that M&A speculation could help drive [Soco's] stock with further drilling in Vietnam and west Africa also likely to provide catalysts in mid-2010," the broker said.

Elsewhere, JP Morgan issued a bus and rail round-up, raising its target price for Firstgroup, up 2 per cent or 8.6p at 438.9p, to 436p from 396p, and for Go-Ahead, down 2.4 per cent or 36p at 1458p, to 1433p from 1333p. Arriva, the broker's "top income pick", rose 3.8p to 494.7p. "With the most consistent DPS [dividend per share] growth in the sub-sector over the last decade, Arriva is our preferred income pick and remains overweight, with scope for our sum-of-the-parts and dividend growth values to rise as equity risk premia fall," the broker said, reiterating its 626p target price.

On the downside, the electricals retailer DSG International retreated 4.7 per cent, or 1.32p, to 26.68p as the market digested a Morgan Stanley circular published overnight. Downgrading the stock to "underweight" from "equal weight", the broker said it was concerned by the extent to which the group was underperforming its main peers in the UK electricals markets, adding that it believed "that the most likely explanation is poor in-store availability". The company rejected the suggestion, saying that it had extremely strong relationships with its suppliers. "We are very comfortable with our stock levels across the group going into the key Christmas trading period," DSG said.