With Royal Bank of Scotland Group (LSE: RBS) (NYSE: RBS.US) reporting profits up last week in its preliminary half-time results, it’s tempting to ask whether the firm is an attractive investment vehicle for capital growth.
Tempting it might be, but as with most temptation, the notion is probably best avoided.
Bumpy times ahead
On the surface, headline figures look good. The firm expects profit before tax to be £2,652 million for the first half of 2014, up around 93% from the £1,374 million achieved at half time in 2013. Operating profit at £2,601 million is up about 267% from the £708 million reached a year ago.
It’s enough to set the heart a flutter. Surely Royal Bank of Scotland has put its troubles behind and morphed into a sparkling new grower set to shoot the lights out for investors on capital growth? Not so fast, cautions the firm’s own CEO. Royal Bank of Scotland has its hands full managing down what he describes as a slate of legacy issues including significant conduct and litigation matters that will likely hit profits going forward. Despite two good quarters, bumps in the road remain, and no one at the bank is complacent about the challenges ahead, he reckons.
Back to a new normal
A bounce back in profits doesn’t presage a new growth era for Royal Bank of Scotland. Profits need to be up, the firm posted dire losses for years. The financial record on profits speaks for itself:
| Year to December | 2009 | 2010 | 2012 | 2013 | 2014 |
| Operating profit (£m) | (2,647) | (469) | (1,190) | (5,277) | (8,243) |
It seems that second-half losses overwhelmed 2013’s first-half profit and that could easily happen again this year. Royal Bank of Scotland continues its restructuring and unwinding of inflated asset positions, and those conduct and litigation issues could bite hard too.
Yet, city forecasters have around £4,378 million of pre-tax profit pencilled in for full-year 2014 followed by a 16% uplift the year after. That’s the new normal for Royal Bank of Scotland and, at today’s share price around 364p, means the shares trade on a forward P/E multiple of around 16 for the current year, falling to around 13.5 for 2015.
That’s not cheap, particularly when we consider the cyclicality inherent in the banking sector. Forward-looking markets tend to compress P/E ratings of cyclical companies as macro-economic cycles unfold, in anticipation of the next profit collapse. That’s a powerful current working against capital growth for investors in Royal Bank of Scotland right now, and the continuing absence of a dividend makes matters worse.
Credit-crunch hangover
The affects of cyclicality on share prices and underlying business performance can be hard to predict. Royal Bank of Scotland crashed hard with the last down-dip and now battles to shrink its pre-credit crunch balance sheet that bubbled up to a highly geared £800 billion or so.
The hangover of unwinding such an over-pumped asset position continues to pound. For example, cash performance struggles and the asset base shrinks:
| Year to December | 2009 | 2010 | 2011 | 2012 | 2013 |
| Net cash from operations (£m) | (992) | 19,291 | 3,325 | (45,113) | (30,631) |
| Net assets (£m) | 94,631 | 76,851 | 76,053 | 70,448 | 59,215 |
Headline profit figures might sound tempting just now, but I want to see what’s happening in the ‘real’ indicators of business worth: cash and assets. We’ll be able to measure progress when Royal Bank of Scotland releases its full-year results around the end of February 2015.
What now?
Royal Bank of Scotland’s cyclicality rules the firm out as a growth investment for me.