Barclays Stock: Cost Savings Support Ambitious Financial Targets (NYSE:BCS)

Introduction

Barclays PLC (NYSE:BCS) shares have enjoyed a very strong run post the release of the bank’s Q4 2023 result on 20 February 2024. The quarterly release was published alongside an Investor Update, in which management set out the group’s new strategy and financial targets.

On 01 March 2024, Barclays shares closed at 169.52p (LSE: BARC) on the London Stock Exchange “LSE,” having gone ex-dividend 5.30p on 29 February 2024. Including the dividend, BCS has returned 17.3% since the Q4 2023 result was released. Following my most recently published Buy call on BCS in late October 2023, BCS has delivered a return (including the dividend and based on LSE pricing) of ~35%. The recovery in the BCS share price since October 2023 has exceeded my expectations; with the FTSE only up by ~4% over the same period, the strong performance warrants a review of my rating on the stock.

In this note, I’ll take a look at some of the key issues raised in the Investor Update and consider whether or not BCS still has enough upside to support a Buy rating.

Structural Cost Actions

The BCS Q4 2023 result flagged that a large restructuring charge would be incurred in the final quarter of FY23. At the time, I criticized management for the lack of detail regarding the restructure costs and the associated cost savings that would follow – refer to my previous BCS Seeking Alpha note for more detail. Having left the market hanging for a few months, with the Q4 2023 result BCS provided numbers for the “structural cost actions” (in non-Barclays speak, this means restructuring) and revealed a new divisional operating structure.

Q4 2023 structural cost actions (“SCA”) came in at £927m, approximately ~£100m higher than consensus had been expecting. BCS point to cost savings from the Q4 2023 SCA of ~£500m in FY24E, and a payback period of less than two years. A cost saving of ~£500m pa is material in the context of BCS FY23 pre-tax profit (excluding SCA costs) of ~£7,500m. I should note here, that as is almost always the case with such cost-out programs, investors would be foolish to assume that the whole £500m pa benefit will drop to the bottom line.

Exhibit 1:

Any assumption regarding the proportion of the Q4 2023 SCA savings benefit of ~£500m pa that will sustainably be captured by the group is subjective, and numbers are likely to vary materially between bulls and bears on the stock. As a general rule in such circumstances, my starting point is that ~25% to ~50% of management’s projected savings will drop to the bottom line. An investment case that is heavily dependent upon management cost-out projections always leaves me feeling rather nervous, so I avoid putting too much faith in such forecasts.

For BCS, there is a lot of scope for analysts and investors to adopt very bullish forecasts regarding cost-out, as management flagged further SCA costs and associated savings in FY24 and beyond. Exhibit 2 is taken from the Investor Update presentation, and highlights that management are aiming to deliver a further £1.5bn of savings in addition to the £500m of savings ‘secured’ by the Q4 2023 SCA charge.

Exhibit 2:

I will admit to being somewhat confused by the numbers that BCS has put out in the slide above. The Q4 2023 SCA charge of £927m was sufficient to allow management to claim a £500m pa cost saving benefit. However, the next £1.5bn pa of claimed cost savings are to be secured via SCA charges of only £600m to $900m (being £200m to £300m pa for FY24 through FY26). Why is there such a large difference between the SCA charge per £m pa of cost saving benefit between the Q4 2023 SCA charge and the SCA charges over FY24-FY26? I don’t have a good answer to this question, and so I am rather skeptical about the ability of BCS to deliver on the total £2bn cost-out target.

New Divisional Structure

The new divisional operating and reporting structure outlined in the Investor Update (refer Exhibit 3) will obviously not directly change the economics of the business, but it will provide investors and analysts with a clearer view of the important drivers of earnings. The most significant change in this regard is that the new structure will clearly split out the group’s investment banking operations and the U.S. consumer banking business. It is common for large banks to tinker with operational segmentation, typically once a decade or so – much to the temporary annoyance of analysts who then need to rebuild financial models – and I do not read anything particularly negative or positive into the change.

Exhibit 3:

Simplification

One aspect of the new structure/strategy did leave me scratching my head, although this was actually flagged slightly before the Q4 2023 result in a market update announcing the acquisition of Tesco’s retail banking business.

As previously disclosed, Barclays is currently engaged in a process to sell its German consumer finance business (comprising credit cards, unsecured personal loans and deposits) as part of our ambition to simplify Barclays and support our focus on growing our key businesses. Any sale, if agreed, would be expected to be accretive to Barclays’ CET1 ratio.

Source: Barclays market announcement, 09 February 2024.

Management pointed to simplification as the main justification for the sale of the German consumer facing business. BCS was a horribly complex beast prior to the Global Financial Crisis; it took a long time to unwind that complexity and create the BCS structure that exists today. Exhibit 4 summarizes some of the changes made over the last decade (along with a few bullet points relating to planned changes). BCS has had its fair share of problems over the years, many of which have deserved criticism, but I also think that the group has executed quite well on what has been a complex program to simplify the business.

Exhibit 4:

Whilst I understand the attraction of further simplification, I also see downsides of exiting a German consumer banking business (that the previous CEO and CFO had talked very positively about) at the same time as ramping up UK retail banking exposure via the Tesco deal. For me, diversification has been a positive feature of the BCS investment case, and the intended move to swap German exposure for more UK exposure diminishes that positive.

New Financial Goals

Exhibit 5 shows the new financial goals that BCS has set. The ambition to improve the statutory RoTE from 9% at FY23 to be above 12% in FY26E strikes me as rather ambitious, and I think the market feels the same way. Although the BCS share price has had a decent bounce post the FY23 result, the stock is currently trading (on the London Stock Exchange) at a discount to NTA of around 49% – this is clearly inconsistent with investors anticipating that BCS can generate a RoTE of >12% in FY26E. If the market is wrong and BCS can actually deliver on the FY26E RoTE target, then the potential share price upside from here will be huge.

In regard to the other goals, I place relatively little weight on the cost-to-income target. Cost-to-income ratios are sensitive to movements in both income and expense levels, and the number of underlying variables at play provide management with plenty of potential for reasons as to why the target might be missed. The income growth target – to achieve group income of ~£30bn in FY26 – implies an average income growth rate from FY23 of ~5.7% pa; I regard this as a pretty ambitious, but potentially achievable goal.

Exhibit 5:

I’m sure that some analysts and investors will be pleased to see that BCS plans to reduce the proportion of the group’s capital that is allocated to investment banking activities. I have a neutral view on this aspect of the strategy. BCS has performed well in several investment banking sub-markets over recent years, and depriving the business of future growth capital runs the risk of reducing the quality of the franchise. I should note that the starting point for the “Investment Bank RWA (% of Group)” of 63% is a bit misleading – this 63% is based upon the current Corporate & Investment Bank segmentation, whereas the new Investment Bank segmentation for FY26 is different, and would line up with a ratio of 58% at FY23 if applied consistently. So, although the initial optics imply a reduction in capital allocation to investment banking of 13%, the actual targeted change is only ~8%.

In a further twist, part of the down-weighting of the capital allocation to the investment bank will be delivered by increased capital allocation to other divisions driven by non-organic actions – the Tesco Bank deal will add £8bn of RWA to Barclays UK, and a change in regulatory capital requirements will increase the US Consumer Bank RWA by ~£16bn.

Closing Remarks & Rating Update

After delivering underwhelming quarterly updates in both Q2 2023 and Q3 2023, BCS shareholders will have breathed a sigh of relief at the market’s reaction to the Q4 2023 result and Investor Update. On balance, I also took more positives than negatives from the Q4 2023 numbers. The Q4 2023 NIM for Barclays UK was materially better than management had guided to at Q3 2023; my valuation has increased in response to this improvement. Whilst I have taken a conservative view in regard to the sustainable earnings benefit from the cost-out program, this change has also contributed to a valuation uplift. The move to further simplify the business is sensible enough, but I do not see this change as particularly significant for the overall BCS investment case.

Investors and analysts who feel confident that management can deliver on the new financial targets for FY26E are likely to conclude that BCS is still extremely cheap (even after the post-result bounce). For me, the FY26E targets appear rather ambitious, and I am not willing to factor much of the potential upside from achieving these targets into my valuation. However, the incremental valuation positives noted above are sufficient to support a continuation of a Buy rating, albeit with a lower potential share price upside expectation than I have previously observed (based on a 01 March 2023 LSE closing price of 169.52p).

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