Analysts divided on Barclays

Barclays (BARC) was the biggest blue-chip gainer on Tuesday, adding around 4%, as it reported its full-year results and unveiled its strategic review.

Pre-tax profits plunged from £5.9 billion in 2011 to £246 million in 2012 after the bank set aside money for compensating customers mis-sold products. On an adjusted basis, profits rose by 26% to £7.05 billion, in line with analysts' expectations.

"Although the profit number looks large on an absolute basis, relative to the capital employed to generate it, profitability is still way too low," warned Louise Cooper of CooperCity.

The bank set aside £1.6 billion to compensate customers mis-sold payment protection insurance (PPI) and £850 million for those mis-sold interest-rate hedging products. It also wrote down £4.6 billion on the value of its own debt.

Dividend dwarfed by bonus pool

Barclays raised its dividend by 8% from 6p per share to 6.5p as a signal of increased confidence to shareholders. Still, the dividend payout of £733 million was dwarfed by £1.85 billion bonus pool paid or set aside for staff, mainly in its investment bank.

"Just like a Premier League football team, this was a bank run for the benefit of its top players," Cooper noted.

But chief executive Antony Jenkins said the glory days were over, pointing out the group compensation to net income ratio declined to 38% from 42% last year and adding that total incentive awards declined 16% for the group, and 20% for the investment bank.

"We believe a ratio in the mid-30s is a sustainable position in the medium term... enabling us to deliver a greater share of the income we generate to shareholders," he said, emphasising that from 2014, Barclays would accelerate its progressive dividend policy, targeting a payout ratio of 30% over time.

"So the balance of rewards will shift back more to shareholders from staff, which should be good for the stock price as investors will pay more for a greater share of the profit pot," Cooper stated. She stressed, however, that Jenkins could only enact this new lower-pay, more moral regime "because the profitability of [the] investment bank has fallen substantially. It would be impossible to instigate his new rules in a booming business."

Return on equity "not acceptable"

The most outstanding headline of the bank's strategic review was Jenkins' statement that the "return on equity is not yet at an acceptable level". He committed to hit a return on equity "in excess of the group cost of equity in 2015", assumed to be at 11.5%. This compares to an adjusted return on equity of 7.8% in 2012.

"The 11.5% target return for 2015 will only just cover the bank's cost of equity," Cooper pointed out. "So for seven to eight years, the profitability will be below capital cost. That is extraordinary and shows the true cost of the years of excess. It will take the bank almost a decade to recover."

Barclays also announced it was aiming to reduce costs by £1.7 billion, helped by cutting 3,700 jobs. The job cuts, which would take place in 2013, would result in a restructuring charge of close to £500 million in the first quarter of 2013.

A "changing" Barclays

Barclays also confirmed it was closing its structured capital markets (SCM) business, which helps clients avoid tax.

"The division only employed 100 staff and yet reportedly made £1 billion in profits," Cooper noted. "This is a radical move for a bank that is desperately in need of profit to rebuild its capital base. The closure of SCM is the biggest signal of all that Barclays is changing."

Jenkins echoed this view: "The behaviours which made headlines during the year stemmed from a period of 20 years in banking in which the sector became too aggressive, too focused on the short term, and too disconnected from the needs of customers and clients, and wider society.

"Barclays was not immune from the impact of these trends, and we suffered reputational damage in 2012 as a consequence. Change is needed both in our industry and at Barclays."

Looking ahead

In an interview with Bloomberg, Jenkins appeared quite cautious about the future financial performance of the group, stating it is a "fundamentally different environment" than the past, characterised by "muted economic growth" for the next few years, implying top-line growth will be "low single digit".

In such an environment, he said a return to profitability required "cost cutting and a better use of capital". In the strategic analysis of the bank's 75 business units, he hinted that only 39 were considered core, deserving of focus and attention, while the rest would be exited or at least reduced in size.

Analyst view

Ian Gordon, analyst at Investec, reiterated his 'buy' recommendation on the stock, pointing out that the stock was trading on a tangible net asset value ratio of 0.8 times, in line with Royal Bank of Scotland (RBS), which it rated 'sell' and at a discount to Lloyds Banking Group (LLOY), also rated a 'sell'.

"This appears to be a relative pricing anomaly given that we expect Barclays' stated return on equity to recover to c. 10% by 2014 - well ahead of its (currently loss-making) domestic peers," he stated.

Cooper noted that Jenkins was hitting hard, sending a message to staff that the "Premier League football" days of the past were over.

"In the words of a former Barclays investment banker on Panorama [on Monday] on the glory days: 'If you could bring home the bacon you could do anything'. But bacon is harder to come by now," she acknowledged.

"Trading volumes in many markets are low and falling. There is little [merger and acquisition activity] or [initial public offerings] and yield curves are flat, which limits trading opportunities. [Foreign exchange] and fixed income are the only areas doing well.

"I wish Jenkins the best, but I fear his regime has a long way to go. Any new broom needs to sweep out past filth."

Marc Kimsey, senior trader at Accendo Markets, was more optimistic: "Barclays delivered exactly what the trading floor wanted - a solid set numbers, aggressive cost-cutting plans and a reiteration of the strategic overhaul.

"This draws a line under the legacy issues that have tainted the bank in recent months, will please shareholders and go some way to improving the company's image. A dream start for Jenkins, the numbers are decent and the trimming of the investment banking arm and bonuses will be well received by the 'bank bashers'.

"I can hear the analysts sharpening their pencils, upgrades and increased price targets to follow."

Analysts at Killik & Co disagreed: "With [a] very strong [share price] performance year to date, we retain our 'neutral' recommendation."

Barclays' stock has jumped 20% since beginning of the year.