Equity Bottom-Up

Brief Equities Bottom-Up: Lloyds Banking Group (LLOY LN): Growth Who Needs It? and more

In this briefing:

  1. Lloyds Banking Group (LLOY LN): Growth Who Needs It?
  2. Centrica PLC (CNA LN): Lots of Gas but No Fizz
  3. TAL Education (TAL): Online Courses Improved Margin in 3Q19, Parents Returning, 44% Upside
  4. US Speciality Lenders – Worse Credit Metrics, Especially Personal Loans
  5. Credit Bank of Moscow: A Highly Ranked EM Opportunity

1. Lloyds Banking Group (LLOY LN): Growth Who Needs It?

Mortgage savings

The political decision to exit the European Union has unpredictable negative consequences for both the UK economy and stockmarket. My purpose is to identify a portfolio of UK shorts and occasional longs.   

Lloyds Banking: What does it do ?

Lloyds Banking Group is the UK’s largest retail bank with a 20% share of both consumer credit and mortgage lending. It has no investment banking activities or overseas activities.

Why is it in the long portfolio ?

After a 10 year period of rehabilitation post the Financial Crisis the group is now profitable at the statutory level and generating a healthy double return on tangible equity (ROE). This year the consensus expectation is for a dividend of 3.3p per share (+7%) leaving the shares on a yield of 5.7%. In addition management completed a GBP1bn share buyback, the combination of buy-back and divided represents 4.7p per share or an effective yield of 8.1%. If future projections prove correct then the ROE should morph into the mid-teens by 2020. A return at this level should be sufficient to lift the shares well above book value. 

What are the risks ?

A key risk is economic dislocation from Brexit. Management believe that EU exit along the lines of the current withdrawal agreement will be compatible with only a marginal increase in credit losses.

2. Centrica PLC (CNA LN): Lots of Gas but No Fizz

Prices

The political decision to exit the European Union has unpredictable negative consequences for both the UK economy and stockmarket. My purpose is to identify a portfolio of UK shorts and occasional longs.  

Centrica PLC: What does it do ?

Centrica, through its operating subsidiary British gas is the largest of the six major energy supply companies operating in the UK. The core activity, and providing around 70% of revenues, is energy supply to households and businesses in the UK, US and Canada. The group has a 28% share of the home energy market in the UK and 13% of the market in US. In energy supply to businesses, Centrica is the second largest supplier in the US where it claims a 15% market share. Beyond energy supply Centrica has three established business, Services, Trading, and E&P, and two nascent high growth businesses Distributed Energy & Power and Connected Home

Why is it in the short portfolio?

Energy Supply is dominated by regulation and price conscious consumers which has lead management to predict a flat revenue outcome over the long term. Customer numbers are declining, the recently introduced default tariff price cap will eat into revenues, and higher gas prices are unhelpful.

Recognizing the problem management intend to treat Energy Supply as a cash-cow re-investing its cash-flow into the growth businesses. However the available upside from these new ventures may not provide sufficient compensation. More immediately consideration of cash-flow suggests the dividend, currently supporting the shares with a near 9% yield, may not prove sustainable.

3. TAL Education (TAL): Online Courses Improved Margin in 3Q19, Parents Returning, 44% Upside

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  • We believe that parents of primary school children will bring their children back to tutoring schools when they become aware of the competition in junior high schools.
  • The expansion of online business and the change towards small classes are improving both the revenue growth and the margins.
  • We believe that the requirement of educator license is not a concern.
  • The 5-year P/E band suggests an upside of 44% for the share of TAL Education.

4. US Speciality Lenders – Worse Credit Metrics, Especially Personal Loans

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We look at credit metrics of three specialty lenders in the US, for newly announced results. Discover Financial Services (DFS US) mostly provides credit card loans, but additionally it provides student loans and personal loans. The last category is where there is the most deterioration in the just-reported 4Q18 results, and it goes to our concerns about the reported ‘robustness’ of the US economy.  The company’s charge off rate in personal loans rose to 4.49% in 4Q18. The figure was 3.62% in 4Q17 and 2.70% in 4Q16. This is considerable deterioration. Even where some of the credit metrics in credit card loans is not as dire, the direction is of concern. All said, perhaps this is one reason that DFS falls into our growing bucket of financial companies with declining QoQ profit in 4Q18? Credit metrics at Sallie Mae and Synchrony Financial, do not leave us sanguine about the US consumer either. 

5. Credit Bank of Moscow: A Highly Ranked EM Opportunity

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Founded in 1992 and acquired by Mr. Roman Avdeev in 1994,Credit Bank Of Moscow Pjsc (CBOM RM) benefits from an entrenched market position and strong brand recognition in its strategic market of Moscow which represents 25% of Russian GDP. CBM is an established operation in Moscow and the Moscow region with over 7,000 devices in high traffic locations.

CBM has expanded fast, from commanding a mere 0.7% share of system Assets in 2013 to 2.9% today.

The bank has a defined strategy underpinned by blue-chip, large, and medium-sized corporate services (fees, settlements, cash handling); high-margin consumer lending; and investment banking (SOVA Capital synergies, interbank, ECM, DCM, M&A). CBM commands a client-base of 15k corporates: companies represent 87% of loans. The bank has 1.5MM retail customers: accounting for a third of deposits.

In 2015 CBM acquired Inkakhran, swelling its nationwide cash handling market share to 17%. In this segment, CBM commands a client-base of 3k, of which 164 are banks, with 876 armoured vehicles covering 33k collection points.

Management is focused on above-system growth, based on a relatively robust liquid Balance Sheet, reducing funding costs, and enhancing operating efficiency and productivity. 2018 was marked by building up liquidity and strengthening capital adequacy as well as managing Balance Sheet risk -after 5 years of forceful growth- while maintaining profitability and cost efficiencies.

Technology highlights include the Your Bank Online system, MKB Business, and Foreign Exchange Control Dashboard.

Avdeev’s Rossium, a domestic group with interests in agriculture, timber, oil and a pharmacy chain, is the majority shareholder (56%) while the EBRD holds a position which reduces the float (18%). The supervisory board contains 5 out of 10 independent non executives while 2 more are nominees of minority shareholders. Related party lending is 3.5% of the loan book. Rosneft exposure though represents a caveat to CBM and to the system in general though some view this more of a strength.

CBM trades below Book Value, lies on a low Mkt Cap./Deposits rating of 13%, below the global and EM median, and commands an Earnings Yield of 13%. A quintile 1 PH Score™ of 8.0 captures the valuation dynamic while metric change is satisfactory. Combining franchise valuation, technical momentum, and the PH Score™, CBM stands in the top quintile of opportunity globally.

 

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