AIB is trading at six times its net asset value, whereas Bank of Ireland’s valuation is more in line with the market
First published: Tue, Aug 19, 2014, 01:20
Ireland’s banks are finally back in profit. Bank of Ireland (BoI) reported gains of some €399 million for the first half of the year, while AIB made some €437 million in profits for the same period. But does this mean that the good times are back for the banks and it’s time to reinvest?
Well, if you’ve been bitten once by an Irish bank investment, you might be shy this time around. Nevertheless it seems plenty of people are still thinking that investing in either AIB or BoI is a good way to play the recovery in the Irish economy.
Paul Sommerville. of Sommerville Advisory Markets, says he has been “inundated with enquires regarding buying Irish bank shares”.
As Vincent Digby. financial advisor with Impartial, has noted, some of it is about people trying to make up for the losses they have incurred over the last few years.
“Almost everyone has suffered to varying degrees in the downturn, so as we’re seeing the recovery start to come around, people want to see if they can benefit in some way in the upturn.”
But, given all that has happened in the past few years – recapitalisations and preference shares to name two – investors need to understand, before they spend any money, just what it is they might be investing in.
For some investors AIB, which is currently trading at nine cent, compared with BoI’s 28 cent or so, looks like a good bet. However, while AIB continues to be quoted on the Irish Stock Exchange, Merrion Stockbrokers banking analyst Ciaran Callaghan says it’s important that retail investors realise this share price is not a true reflection of the stock.
“Its share price is significantly inflated,” he says. “It’s trading at six times net asset value while its European peers are trading at roughly 1x time. So, in effect, it’s six times overvalued”.
This means that the truer share price of AIB is closer to one or two cent – regardless of what its stock exchange listing might say.
“I would caution anyone buying into it. It’s not a true valuation or a realistic price. Beware,” says Callaghan.
Digby agrees: “I have been strongly warning people that there’s a delusion with the pricing,” he asserts.
Indeed AIB has a market capitalisation of €47 billion, which bizarrely puts it among the largest quoted banks in Europe, larger than Deutsche Bank, Credit Suisse and Standard Chartered, and very close in scale to Ulster Bank’s owner, Royal Bank of Scotland.
However, while even Minister for Finance Michael Noonan has flagged the anomaly, retail investors continue to remain invested in the billion shares or so that are in free float, and are driving movements in its share price, with some of the other activity accounted for by day traders looking to make and take a quick gain.
What’s driving this share price issue is the sheer volume of outstanding shares – some 523 billion, compared with about 32 billion at BoI, for example. As was noted by both Noonan and AIB itself in its interim statement at the start of the month, some 500 billion ordinary shares were issued to the National Pension Reserve Fund in July 2011 at a price of €0.01 per share.
It’s likely that AIB, with the approval of the Government as a 99.8 per cent shareholder, will at some point consolidate the shares and lower the amount in circulation. That may push the price up. However if you buy now, according to Sommerville, “you will gain no monetary benefit from this”. “If you want to buy AIB and believe it will recover well, you will have to wait until the Government sell some part of the bank so there is a proper liquid market in the shares,” he says.
Buying now means “you are literally throwing money away” he adds.
The current anomaly in AIB shares also means it’s unlikely the Government will be able to secure an outside investor until it rectifies the situation. Given that the Government is likely to want to do this before the general election
in Q1 2016, it is a timely concern and one you would expect would be fixed post-haste.
However, as Callaghan notes, the issue is further complicated by the fact that the Government also has a preference share in AIB, and the bank is currently in discussions with the Department of Finance about restructuring its capital profile.
“One of the scenarios is a potential conversion of the Government’s preference share into equity. This would mean more shares in issue, so it makes more sense for the bank to address its capital restructuring first, before they move to attempt to rectify the share price,” he says.
If you are still keen to put your money back into AIB, the best advice is to wait until its share price is normalised and is trading in or around 1x net asset value, as per other European banks.
When the bank will be in a position to pay dividends again also depends on it sorting out its capital structure, and putting money aside for this purpose.
Bank of Ireland
Without the same free-float issues, BoI, which is currently trading at about 28 cents, is considered to be a different kettle of fish. While it too has a relatively high number of shares in issuance, at about 32 billion, it has a more realistic market capitalisation of €8.6 billion.
“It’s a very liquid stock, and you can buy into it any day. Its valuation is more broadly in line with the overall banking sector, and it’s more fairly priced than AIB,” says Callaghan. “Its market cap is a realistic reflection of its assets and earnings stream and there is no artificial anomaly that people have to be aware of.”
Callaghan has a price target of 31 cent on the stock, and there is a general sense of optimism around it. Of the 16 analysts that cover the company’s stock and are polled by Bloomberg, 50 per cent have it rated a buy; 16 per cent say it’s a hold; and 33 per cent rate it a sell.
“But there are still challenges ahead – its loan book is contracting and its margins are stabilising,” says Callaghan. In addition, there is also the risk of a “small capital raise” following upcoming stress tests.
If the bank does come through the ECB’s Comprehensive Assessment with a clean sheet, the Irish economy continues to improve and the bank’s loan book starts to grow again, it’s possible the bank’s share price will rise even further.
This is not to say however, that BoI is heading back to its glory days.
“I think it’s a reasonable prospect for exposure to the economy, but it’s money you have to be prepared to lose. It still has a speculative edge to it,” says Digby.
As Callaghan notes, when BoI was at its peak it had a market cap of about €15-16 billion – so even if the bank’s market cap was to double today to that same level, a doubling of its share price would only see it rise to about 50 cent. If you’re either waiting for BoI to recover its old share price, or you’re investing for the long-term in the expectation that it will return to this level again, it might be time to reconsider.
“It’s not the same as BoI of old. You need to change your mindset,” urges Digby.
With respect to dividends, once the bank, in line with its plans, redeems some €1.3 billion in preference shares outstanding – which is scheduled to happen before July 2016 – it could start to conserve capital to start paying a dividend in 2017, provided that no other significant issues arise.
Look overseas for bank stocks
Finally, if you want to benefit from the relative recovery in bank stocks, or be invested for the gains if and when they should come, there’s a world of opportunity outside of Ireland. Exchange-traded funds tracking an index of financial stocks offer an element of diversification and may be a safer bet than opting for an individual stock.
For example, the Ishares US Financials ETF is up by 89 per cent over the last five years, while the SPDR Financial Select Sector is up by 84 per cent over the same time frame.