Barclays (LSE: BARC) (NYSE: BCS.US) announced sweeping cuts to its investment banking division yesterday, triggering a surprising 8% rally in the bank’s share price, which shot up to 262p.
The bank’s entire European business will join £90bn of its investment banking assets in a new ‘bad bank’, and a tough set of financial targets were announced, aimed at strengthening the bank’s balance sheet and improving its profitability.
I reckon these targets fall into the ‘tough but achievable’ category — and if Barclays succeeds, the rewards for shareholders could be considerable, as I’ll explain.
1. 11%
Barclays is targeting a Common Equity Tier 1 (CET1) ratio of more than 11% by 2016, up from its current level of 9.6%.
The CET1 ratio is a key regulatory measure, and anything less than 10% is considered risky, although the current minimum requirement is only 7%.
Barclays can increase its CET1 ratio in two ways — by disposing of risky assets, or retaining more of its profits and using these to increase its capital. Barclays intends to do both, by disposing of £50bn of non-core assets by 2016, in addition to retaining more of its profits.
My calculations suggest that the planned asset disposals alone should boost Barclays’ CET1 ratio to around 10.9%, so a target of over 11% seems reasonable — and would be well received by big investors.
2. 3.8% yield
Barclays is planning a medium-term dividend payout ratio of between 40%-50% of underlying earnings, but until it hits the targets I mentioned above, it plans to restrict dividend payments to 40% of earnings.
Barclays’ adjusted earnings per share are expected to be around 25p in 2014: a 40% payout could mean a dividend of 10p per share, giving Barclays a tasty prospective yield of 3.8%.
3. 25% profit growth
Profits from Barclays’ African retail banking business rose by 25% in 2013, and they’ve risen by 25% during the first quarter of this year, compared to the same period last year.
Although Barclays’ African operations currently account for a modest 6% of the bank’s total pre-tax profits, I believe they could deliver significant long-term growth. It’s no coincidence, in my view, that Barclays’ previous chief executive, Bob Diamond, is now focusing all of his attentions on African banking.
Is it too late?
Yesterday’s news added around 20p to Barclays’ share price, but in my view the bank’s shares are still cheap, on a 2014 P/E of just under 10, and a prospective yield of 3.5%.