Juggling ups and downs at Barclays

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

In January I wrote regarding bank shares, "It is darkest before dawn" and "perverse actions can be the hallmark of successful investing". I drew attention to Barclays (BARC) in particular given its management's confidence in the group's financial position which was also manifest in a determination to avoid Government assistance.
 
The shares were then trading at a low of about 50p and on the following Monday (26 January), Barclays contradicted bear rumours by publishing an open letter from its chairman - with headlines uniquely 'shouting' in capitals, that financial resources were in excess of regulatory requirements and no further money was sought. The shares opened at 60p and doubled over the next week or so, although fears resurfaced over Barclays' balance sheet such that the price soon dropped back near 60p again.
 
This showed how wavering sentiment towards the group's highly geared balance sheet, with some £2 trillion liabilities versus £43.6 billion equity, is the key factor for traders to understand. It also makes the shares a prime play on whether the Government's gamble with deficit spending, signalled in the Budget to increase, will work to spur economic recovery.
 
The shares soared after a 27 March announcement that the Financial Services Authority (FSA) had 'stress tested' Barclays' balance sheet and profit and loss account, to conclude the group is within the FSA's capital requirements. The price breached 250p amid selective good news from the US banking sector and a wider market recovery - again, bear in mind that especially in this sensitive time for wider market sentiment, bank shares are prone to amplify the moves. 'Stress testing' obviously has to prove itself in the real world and sentiment remains fragile as shown by a quick retreat to 200p as soon as markets dived.
 
At this level, Barclays is capitalised near £17 billion relative to end-December net assets of £43.6 billion or 520p per share, but (as often perplexes people about bank shares) this figure is hardly dependable when a modest variance in the massive liabilities can dramatically alter it.
 
This explains the difficulty in targeting intrinsic value; why such estimates have varied greatly. If Benjamin Graham, the 20th century American dean of investment analysis, was still around to take a look at Barclays, he would likely give the shares a miss because unless you take an optimistic view on economic recovery you cannot define a margin of safety in the shares. Strictly speaking they are not 'investment grade'.
 
Yet buyers and holders justifiably sense that if Barclays can overcome the medium-term challenge of this recession then in three to five years' time it should be well-placed internationally besides the UK where various other banks are under Government influence. Barclays is now the largest market maker on Wall Street, having acquired investment banking interests in last year's fallout of Bear Stearns. This makes the shares' risk/reward profile enticing if you can stomach the risks.
 
The International Monetary Fund has just recently warned credit crunch losses could reach £2.75 trillion equivalent, damaging the financial system for years and delaying economic recovery; that banks generally may need further capital and the cost of the bail-out will impact the already debt burdened UK Government finances. Such a gloomy prognosis both tempers upside in bank shares for the medium term yet is likely to lead to further buying opportunities ahead - why I reiterate keeping Barclays on your watch list.
 
Injecting public money into the banking system (to get banks lending to each other and ultimately customers) appears to be having some effect. The latest Bank of England survey expects business lending by UK banks to strengthen although for consumer demand for loans to remain weak. Despite this mixed outlook, it is a modest tonic to investor sentiment amid wider gloom.
 
Such economic indicators need watching carefully - likewise developments in the US banking system as they quickly affect sentiment here.
 
Yet even in a worst case scenario of a dire recession forcing another capital-raising, Barclays' long-term potential ought to make a rights issue feasible - and the now severely constrained UK public finances must temper politicians' interest to engage more banks.
 
Company REFS shows an analysts' consensus for a drop in pre-tax profit to about £3.7 billion this year and £4.6 billion next, although there is huge variance with Panmure Gordon (PMR) projecting a £5 billion loss this year and £3.7 billion next. This looks overly negative with economic indicators suggesting the rate of global decline is easing and Barclays' management trumpeting a fine start to 2009. But it is premature to assume an uptrend is in place; the future still largely depends on the economic direction and how Barclays' £2 trillion liabilities fare.
 
The sale of iShares, a global leader in exchange traded funds, raised £3 billion with analysts again divided: bulls regarding this as a good price for Barclays and bears emphasising the loss to group earnings. Well something had to give if the objective was to avoid Government involvement.
 
Barclays is mainly a capital growth play for recovery, there is also a wide variance in expectations over dividends and in any case even a fat yield barely compensate for the balance sheet risks in a deep chronic recession.
 
This interplay between positives and negatives guarantees exciting prospects for traders, also a long-term recovery play if you are reasonable enough with timing.
 
Keep an eye on our episodes of iBall TV, as Barclays is due to get the once over from our crack televisual team very soon.

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