General Views Of Standard Chartered Plc Headquarters As Banks Announces Plans To Cut 15,000 Jobs...A sign hangs above the entrance to the headquarters of Standard Chartered Plc in London, U.K. on Tuesday, Nov. 3, 2015. Standard Chartered Plc dropped the most in more than three years after the lender said it plans to eliminate 17 percent of its workforce, scrap the dividend and tap investors for $5.1 billion as Chief Executive Officer Bill Winters seeks to restore profit growth. Photographer: Chris Ratcliffe/Bloomberg
Standard Chartered’s proposed sale of its stake in Indonesian bank Permata would free up capital and likely boost return on equity © Bloomberg

Buy: Standard Chartered (STAN)

The shares are trading at just 0.6 times forecast net tangible assets, the lowest of the “big five” UK-listed lenders, writes Emma Powell.

A $900m (£687m) provision for historic violations of US sanctions and FX trading issues may have weighed on statutory figures for Standard Chartered during 2018, but even on an adjusted basis, a 28 per cent rise in pre-tax profits missed consensus expectations. That primarily reflected weaker income, which came in at the bottom-end of management’s 5-7 per cent target growth range.

However, the lender’s focus on premium banking customers — which contributed more than half of retail banking income — and growth in higher-returning financial markets business, helped boost the underlying return on tangible equity to 5.1 per cent, from 3.9 per cent. However, that figure is still below the banking group’s cost of capital.

Despite chief executive Bill Winters citing slower global growth and “the rapid escalation of trade tensions between the US and China” as weighing on client sentiment during the second half of the year, that did not stop the board issuing a bullish set of fresh financial targets for 2021. That included a double-digit return on tangible equity, $700m in cost savings and plans to eliminate the drag of low-returning markets such as Indonesia and the UAE.

Analysts at Shore Capital expect adjusted net tangible assets of 1,284 cents a share at the December 2019 year-end, up from 1,168 cents the same time the year before.

The share price partly reflects the lender’s weaker dividend payments and returns on equity. However, we think the level of discount is too severe, given improvements on both those metrics and the common equity tier one ratio is ahead of management’s 13-14 per cent target.

Hold: Finsbury Food Group (FIF)

Finsbury Foods has been driving capital expenditure in recent years, updating production facilities and investing in automation, writes Julia Faurschou.

In January, Finsbury Food Group warned that sales in the first half would fall short of the comparable period in full-year 2018. Indeed, total sales fell 3.5 per cent to £152m, though they were up 0.5 per cent on a like-for-like basis.

The decline stemmed from the UK bakery division, where revenue fell 5 per cent to £133m due in part to the loss of revenue from the closure of the Grain D’Or bakery business.

These closed bakeries were lossmaking, so operating profit for the period increased by 0.6 per cent to £7.4m with an increase in margin from 5.2 per cent to 5.5 per cent.

The recent acquisition of gluten-free bakery Ultrapharm has augmented the company’s presence in the growing free-from products segment, while providing a production site in mainland Europe.

Cost inflation faced by the group has persisted. First it was butter that was getting more expensive, now it’s flour. The National Living Wage has added to labour costs, and green levies on energy bills increased the cost of utilities.

Chief executive John Duffy said the group has put through some price increases to help offset these added costs, and the group is using some hedging strategies such as forward buying to address commodity prices.

Analysts at Panmure Gordon expect pre-tax profits of £16.8m during the year to June 2019 giving earnings per share of 8.9p, compared with £17.9m and 9.8p in full-year 2018.

Sell: Reach (RCH)

Net debt almost halved from the year-end to £40.8m and the dividend is well covered by adjusted earnings.

Newspaper publisher Reach completed its acquisition of the Daily Express and Daily Star titles last February, and the integration process is ostensibly running to schedule. Synergy cost savings of £3m were achieved over the course of 2018, and the media group is targeting annualised savings of at least £20m by 2020. It achieved additional structural cost savings of £20m last year, £5m ahead of plan.

Meanwhile, the Express deal underpinned double-digit revenue growth. And adjusted operating profits rose 16.8 per cent to £146m, beating market expectations which had been upgraded as recently as December.

That said, like-for-like sales dipped 7 per cent — suggesting that the overall business is still in slow decline. Moreover, the group swung to statutory pre-tax losses after a £200m non-cash impairment charge. This entailed a previously disclosed £150m provision in June 2018, and another in December 2018.

Reach cited a “more challenging than expected trading environment for advertising revenue generated locally” and short-term Brexit uncertainty. Legal costs from the phone-hacking scandal have also been higher than expected, driving Reach to increase the provision for settling claims by £12.5m last year.

House broker Numis expects adjusted pre-tax profits of £145m and earnings per share of 39.4p in 2019 — down from earlier forecasts of £152m and 41.2p (2018: £142m and 39.2p).

The shares’ lowly rating of 1.5 times forecast adjusted earnings reflects concerns around declining circulation, newsprint price rises and broader macroeconomic issues.

Chris Dillow: A case for cash

Returns on cash are likely to lag behind inflation for years. Mark Carney, Bank of England governor, recently said that rates will rise “at a gradual pace and to a limited extent”, and this only if the “fog of Brexit” lifts. Futures markets are pricing in a three-month rate of only 1.2 per cent by December 2021, which means real interest rates will be negative for at least another three years.

Despite this, there is still a strong case for investors to hold at least some cash, simply as protection against the dangers facing other assets.

Yes, there are reasons to expect equities to rise this year: a high dividend yield on the All-Share index and foreign selling of US shares in the past 12 months are good lead indicators of rising prices. But they are not perfect predictors. There is always the danger that past relationships between lead indicators and subsequent returns will break down.

There are also dangers for bonds. Gilt yields are determined largely by yields on overseas bonds. These could rise if investors fear that the Fed or European Central Bank (ECB) will raise rates. Of course, the weakness of the eurozone economy, plus the fact that inflation there is far below its target, mean there is no pressing need for a rate rise. But the ECB has for years been overpredicting inflation and so has kept monetary policy too tight. Fears that it might repeat these mistakes could push bond yields up.

If markets were to fear rising rates, commodities could also suffer. This is because their prices are sensitive to interest rates. When you hold commodities, you lose the interest that you could be getting from having cash or bonds instead. When interest rates and bond yields are low, this loss is small, which means commodities are attractive, As raises rise, however, the sacrifice increases and so commodities become less attractive.

It’s possible, therefore, that we could see losses on non-cash assets. Worse still, we could see them at the same time. Yes, bonds protect us from some risks to equities, such as the dangers of weaker growth or of investors’ loss of appetite for risk. But they don’t protect us from all such risks, such as the possibility that higher interest rates will trigger a reversal of the “reach for yield” or fears of a slowdown in economic activity.

This correlation risk isn’t the only danger that cash protects us from. There are at least three others:

Liquidity risk. Some assets such as property or private equity become especially difficult to sell in bad times. Having cash prevents us from having to do so. It allows us to be a long-term investor and thus to pick up liquidity risk premiums.

Tail risk. The most you can lose in real terms on cash obviously depends on the rate of inflation. Because this is likely to be quite stable, this loss will very probably be small. But the same cannot be said for worst-case scenarios for other assets. Big losses on equities, bonds and commodities are more likely than a normal distribution would predict; a cubic power law is a better description of the distribution of extreme returns. If you care about minimising worst-case losses, then cash is for you. A 5 per cent real loss on cash over the next 12 months is improbable; the same cannot be said of equities, commodities or bonds.

Fire sale risk. People who are fully invested or, worse still, have borrowed to invest, sometimes have to sell otherwise good assets simply to raise cash in an emergency. This was the story of the collapse of Long-Term Capital Management in 1998, the banking crisis of 2008 (a lot of mortgage derivatives turned out not to be worthless) and it’s also been the story of many over-geared property owners. If you’ve ever been lucky enough to buy a cheap house, it’s probably because you took advantage of somebody’s forced selling. Having cash protects you from falling into such a situation.

Many of you might think there’s another advantage of cash — that it allows us to buy shares when they become very cheap. I’m not sure about this. Equities only become genuine bargains when investors are panicking. But when they are doing so, you might not feel like buying either.

In truth, though, we don’t need this motive to hold cash. Its virtue is that it protects us from dangers that other assets don’t protect us from.

You might object that these dangers are small. But the four most important words in the English language are: “I might be wrong.” The biggest virtue of cash is that it protects us from our own ignorance. And this is always greater than we think.

Chris Dillow is an economics commentator for Investors Chronicle

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