Right now I’m looking at some of the most popular companies in the FTSE 100 to try and establish whether or not they have the potential to push profits up to levels not seen in the last few years.
Today I’m looking at Royal Bank of Scotland Group plc (LSE: RBS) (NYSE: RBS.US) to ascertain if it can make £5 billion in profit.
Have we been here before?
A great place to start assessing whether or not RBS can make £5 billion in profit is to look at the company’s historic performance. Indeed, it would appear that RBS made an annual profit of £7.3 billion during 2007, just before the financial crisis set in. However, back during 2007 there were a number of factors working in RBS’s favour, which are not possible in the current environment.
For example, thanks to the current low interest rate environment, RBS’ net interest margin — a key metric for trying to establish how profitable a bank is — hit 2.15% during 2012, down from the 2.5% reported for 2007. This tiny drop may not seem like much but it’s a 14% decline in interest income, which indicates that RBS is receiving £1bn-£2bn less in interest income now than during 2007.
What’s more, RBS’s cost-to-income ratio, a metric designed to show a company’s costs in relation to income, has jumped 50% since 2007. Unfortunately, this indicates that RBS is going to work extra hard to make money as costs have gone up, squashing profit margins. Furthermore, RBS is now a smaller bank than it used to be, having been forced to sell off some of its most lucrative assets following the government bailout.
But what about the future?
Sadly, RBS has become somewhat of a political bartering tool recently and this is hampering the company’s return to profit. In addition, nearly six years on from the financial crisis, RBS is a shell of its former self with fewer assets with which to generate income from.
That being said, estimates from City analysts currently predict that RBS’s pre-tax profit will surpass £5 billion during 2016. Still, this profit is dependent upon the economic recovery within the UK and political policies. Indeed, if current proposals to split RBS up further go ahead, the bank’s return to profit will be delayed for several years.
Foolish summary
All in all, even though RBS has suffered during the past few years, the bank in the process of returning to growth. Nevertheless, there are still some speed-bumps standing in the way of RBS’s return to profit. So overall, I feel that RBS can make £5 billion profit.