In our view, the key takeaway from the recent 3Q trading statement is how Arbuthnot Banking Group plc (LON:ARBB) is progressing strategically towards its “Future State 2” plan. In particular, we note i) specialist SME finance divisions generating the ambitious balance sheet growth in the plan, ii) optimising the core relationship banking franchise, which, in this period, saw 7% deposit growth ‒ given the level of base rates, this is a profitable product for a relationship bank, and iii) continued investment, which, at times, requires a step change in cost rather than a gentle evolution. To meet expected multi-year demand, ABG is increasing its central London HQ office space by 45% at an annual increase in cost of ca.£5m (with further dual running costs until October 2024 as it is refitted).
- Credit: “The book continues to perform robustly despite the increased credit risk inherent in the current environment. This was a result of a conservative credit appetite, which was tightened over a year ago”. At the interims, we detected the early signs of a gentle deterioration, and our loss expectations are unchanged.
- Impact on estimates: In 2023, we have increased income marginally to reflect the faster-than-expected and profitable deposit growth (also in balance sheet forecast). The profit/loss effect is offset by dual running costs, leaving the bottom line unchanged. 2024 is affected by the full-period effect of higher costs.
- Valuation: Our multiple approaches see a broad range of valuations: £11.58 DDM, £26.23 SOTP and £23.64 GGM (average £20.48, was £21.00), reflecting a marginally lower capital base, reducing the GGM and earnings mix changes. Trading at 57% of NAV is anomalous, in our view, with above the cost of capital returns and ABG’s growth outlook.
- Risks: Margins may have peaked now, with the trend, and level, of interest rates a key driver to earnings. Credit is a risk, but ABG is conservative in lending, taking good security. Short-duration assets and a conservative culture mean there is no OSB read-across. Other risks: reputation, regulation and compliance.
- Investment summary: ABG offers strong-franchise and continuing-business (normalised) profit growth. Its balance sheet strength gives it a number of wide-ranging options to develop organic and inorganic opportunities. The latter are likely to increase in uncertain times. Management has been innovative, but also very conservative, in managing risk. Having a profitable, well-funded, well-capitalised and strongly growing bank priced below book value is an anomaly, in our view.
