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In all the pre-Christmas excitement, some investors may have missed the reduction in the government’s stake in this FTSE 100 bank.
December saw the state’s holding in NatWest (LSE: NWG) fall to 9.99% from 10.99%. This is down from 84% after the bank was rescued along with others during the 2008 financial crisis.
The government is still the bank’s biggest single shareholder. However, Chancellor Rachel Reeves recently reaffirmed its plan to fully exit its investment by 2026.
So, is it now a good time for me to buy more?
How does the core business look?
I see the principal risk for NatWest as being a sustained drop in its net interest income (NII). This is the difference between the income from interest it receives on loans and pays out on deposits.
It tends to drop for banking operations in countries where headline interest rates are trending down. This usually occurs as inflation is on a falling trajectory and looks to stay on the low side.
That said, it is far from clear to me that this will continue for too much longer in the UK. Many UK businesses have warned of the inflationary effects of the October Budget’s 1.2% increase in employers’ National Insurance.
Even without such a rise, I know as a former investment banker that banks can hedge much of their interest rate exposure.
Another risk to NatWest is the high degree of competition in the sector which may reduce its overall profit margins.
How has the bank been doing recently?
That said, last year’s Bank of England interest rate cuts did hit NatWest’s NII. It dropped 1.2% to £8.3bn over the first nine months of the year.
However, interesting for me was that by Q3 the bank had managed to more than compensate for this by simply lending more. Net loans increased by £8.4bn, while deposits increased by £2.2bn.
So ultimately over Q3, its year-on-year NII increased once again — by 8% to £2.9bn. This drove its Q3 operating profit before tax up 25.7%, to £1.67bn, ahead of analysts’ £1.5bn consensus forecast.
As a result, it upgraded its profit guidance for full-year 2024 from £14bn to £14.4bn.
Are the shares undervalued?
The first part of my assessment of stock prices is comparing their key valuations with those of their competitors.
NatWest currently trades at a price-to-earnings (P/E) ratio of just 7.5 against a competitor average of 8.4 So, it looks cheap on this basis. Even Russian Commercial Roads Bank presently trades at a P/E of 8.1 and it is under international sanctions!
The second part of my assessment involves looking at whether a stock is undervalued to where it should be, based on future cash flow forecasts. A discounted cash flow analysis shows NatWest shares to be 57% undervalued at their current £4.14 level.
Therefore technically, their fair value is £9.63, although the vagaries of the market might move them lower or higher.
Will I buy more of the shares?
I believe NatWest will continue to perform strongly in the coming years. This should drive its share price – and dividend – higher.
In fact, analysts forecast its dividend yield will rise to 5.5% in 2025, 6.4% in 2026, and 7% in 2027.
Given this, I will be buying more of the shares very shortly.
This story originally appeared on Motley Fool
