I have used the turmoil over Brexit to purchase 550 shares of Clydesdale Yorkshire Banking Group (CYBG). An undervalued mid-size British bank active in mortgage, credit card and small business lending.
The out-vote of the Brits caught markets off guard, which were clearly pricing in a remaining of the UK in the EU. In the following equity markets crashed because of a flight to safety, in particular into U.S. Dollar, Japanese Yen and Swiss Franc denominated assets. Naturally high rated gov. bonds were in demand sending yields down to record lows. Consequently risk assets all around the world, especially equities witnessed drops not seen since Lehmann Brothers in 2008. Among equities banking stocks have been battered down the hardest. Fears over a liquidity crisis, rising volatility leading to uncertainty and hence further stimulus of central banks pushing down yields and kill off the gentle start of rate hikes in the U.S. weighs on banks. Continued flattening of the yield curve would of course put pressure on bank´s net interest margin and of course overall profitability and hence further stress especially european banks. Consequently bank equities throughout Europe lost up to a third of their value, significantly underperforming the already weak broad markets.
However, “not all banks are created equal” or put in other words “are priced the same”. A writeup by hawkeye901 on Value Investors Club has drawn my attention to Clydesdale Yorkshire Banking Group (CYBG), a British lender recently spun off from National Australian Bank (NAB). During the weeks before Brexit CYBG´s share price has run up nicely from 220 pc to 300 pc, a price I considered a little expensive. However, Brexit has pushed CYBG back into the bargain territory to around 220 pc at which believe the name is a steal. The investment thesis behind buying into CYBG is straightforward.
- The bank is cheap at 0.67 times tangible book compared to peers that trade all well above TBV, since NAB was eager to get rid of non-core assets and Brexit blues.
- The bank has ample room to increase efficiency by downsizing branch network and employee count. In doing so CYBG does not have to go above and beyond but is only required to achieve a cost income ratio in line with peers. CYBG´s CEO has a proven track record. Mr. Duffy successfully performed comparable cost reduction efforts at former employer AIB.
- The bank is overcapitalized with a leverage ratio of 7,1 %. Currently CYBG is using the standard approach to calculate risk weighted assets (denominator of the calculation for capital requirements). If CYBG can get their own model approved it can free up capital and bring leverage ratios in line with peers (4.5%-5,6%) enabling the bank either to grow operations or return excess capital to shareholders.
- If CYBG can deliver on cost cuts and show a cost income ratio of around 50% as well as reach a target return on equity of 10% there is no reason why the bank should not be valued above TBV. A 1.2 times multiple results in a share price of 450 pc, which represents an upside in excess of 100% over the next two to three years.
While Brexit might soften business activity and present some additional headwind to CYBG´s top-line, the company should nevertheless be able to deliver on cost cutting initiatives and hence close the valuation gap to TBV.
To make the purchase I closed my position in Berkshire Hathaway. By no means this presents a lack of confidence in the work of Warren & Charlie. I am very happy to reenter Berkshire when cash is available. The sole reason for selling is that upside of CYBG is incomparably greater and additionally reduces dollar dependency of my portfolio.
Again special thanks to hawkeye901 for the writeup of CYBG on Value Investors Club.