Why Barclays Stock Offers Sizeable Gains

Barclays stock (NYSE: BCS) lost more than 60% – dropping from $10 at the end of 2019 to around $4 in late March – then spiked 40% to around $5.60 now. This implies it’s still 44% lower than the start of the year.

There were two clear reasons for this:  The Covid-19 outbreak and economic slowdown meant that market expectations for 2020 and the near-term consumer demand plunged. This could negatively affect businesses and individuals, impacting their loan repayment capability and exposing Barclays to sizable loan losses. The multi-billion-dollar Fed stimulus provided a floor, and the stock recovery owes much to that.

But we believe there is more upside to come over the coming months 

Trefis estimates Barclays’ valuation to be around $7 per share – about 25% above the current market price – based on an upcoming trigger explained below and one risk factor.

The trigger is an improved trajectory for Barclays’ revenues over the second half of the year. We expect the company to report $27.8 billion in revenues for 2020 – similar to the figure for 2019. Our forecast stems from our belief that the economy will gradually improve in Q3. Further, the easing of lockdown restrictions in most of the world is likely to help consumer demand, benefiting the overall business scenario. The bank’s investment banking operations have driven positive revenue growth in Q1 and Q2 due to higher trading volumes, with the bank’s trading revenues surging by 63% in the first half of 2020 as compared to the year-ago period. On similar lines, Barclays’ underwriting fees saw significant growth in the first half of 2020 due to a jump in debt underwriting deals after the Fed stimulus. This has partially offset the impact of weak revenues in other segments. While we expect the trading income to drop in the subsequent quarters, it is likely to be still higher than the year-ago period. Overall, we see the company reporting an EPS in the range of $0.47 for FY2020.

Thereafter, Barclays’ revenues are expected to improve to $28 billion in FY2021, due to an increase in retail revenues, partially offset by a decline in sales & trading revenues. Further, the net income margin is likely to grow as compared to the previous year due to a decline in provisions for credit losses, leading to an EPS of $0.82 for FY2021.

Finally, how much should the market pay per dollar of Barclays’ earnings? Well, to earn close to $0.82 per year from a bank, you’d have to deposit about $82 in a savings account today, so about 100x the desired earnings. At Barclays’ current share price of roughly $5.50, we are talking about a P/E multiple of just below 7x. And we think a figure closer to 8.5x will be appropriate.

That said, banking is a risky business right now. Growth looks less promising, and near-term prospects are less than rosy. What’s behind that?

Barclays has a huge portfolio of consumer, commercial, and wealth management loans – more than $380 billion in FY 2019. The economic downturn could deteriorate the loan repayment capability of its consumers, exposing the bank to significant loan defaults. In anticipation of this risk, Barclays has increased its provisions for loan losses from around $1.2 billion in the first half of 2019 to $4.9 billion so far – a 4x jump. If the economic condition worsens, this figure could further increase in the subsequent months. Further, a negative economic outlook will make it expensive for the bank to attract funding, increasing the cost of its operations. To sum things up, we believe that Barclays’ stock is currently undervalued and offers upside, given its strong retail and investment banking operations.

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