Arbuthnot Banking Group Plc

2017: capital deployed, adding value

04 Apr 2018 / Corporate research

ABG has a long track record of adding value. The partial sale of its Secure Trust Bank (STB) in 2016 saw significant capital generated, and ABG is now deploying this surplus to generate returns. Despite heavy investment, profits nearly doubled, with loans and deposits up over a third. Credit remains outstanding, with the secured nature of lending seeing 2H’17 impairments of just £51k on a £1bn loan book. The outlook is for further strong profit growth, more investment, and greater diversification by business line and risk exposure. The shares trading below NAV appears an anomaly, given ABG’s track record and earnings growth outlook.

  • FY’17 results: 2017 saw interest income up 25% (driven by loans up 38%), interest expense down 17% (despite 39% deposit growth), net fees and commissions up 23%, impairments down to a record-low 4bps of lending and cost growth of 19%. Underlying profit rose from £4m in 2016 to £7.6m in 2017.
  • Outlook: ABG is only a third of the way through deploying its surplus capital. With the initiatives outlined recently, we see accelerated investment in 2018 (reducing our earnings forecast), but we still predict 37% profit growth. Our new 2019 profit forecast is higher than we had previously estimated for 2018.
  • Valuation: The range of our fully deployed capital valuation methodologies is now 1,476p to 2,630p (previously 1,534p-2,641p), with the impact of lower 2018 earnings largely offset by rolling forward our valuation base year to 2019 from 2018. We note the shares currently trade at 1,355p vs. an NAV of 1,547p.
  • Risks: As with any bank, the key risk is credit. ABG’s existing business should see below-market volatility, and so the main risk lies in new lending. We believe management is cognisant of the risk and has historically been very conservative. Other risks include reputation, regulation and compliance.
  • Investment summary: ABG offers strong franchise and continuing-business (normalised) profit growth. Its balance sheet strength gives it wide-ranging options to develop organic and inorganic opportunities. The latter are likely to increase in uncertain times. Management has been innovative but also very conservative in managing risk. Having a profitable, well-funded, capitalised and strongly growing bank, priced below book value, is an anomaly, in our view.