UBS raised its rating on the stock to ‘buy’ from ‘neutral’ and lifted its target price to 300p from 285p after RBS earlier this month announced its first dividend since it was bailed out by the government in 2008 during the financial crisis.
READ: RBS shares rise as it looks to pay first dividend since financial crisis, posts first half profit
A US$4.9bn settlement with the US Department of Justice (DoJ) over the sale of mortgage-backed securities in the run-up to the financial crisis, marked the last of the bank’s major legacy issues and paved the way for the resumption of dividends.
RBS recommended an interim dividend of 2p as it reported an attributable profit of £888mln for the six months ended June 30, down from £939mln last year, with the decline reflecting its settlement with the DoJ.
“The first dividend in a decade didn't dent the balance sheet either: significant special dividends or buybacks – perhaps direct from government – are needed to stop this undervalued surplus capital from growing further,” UBS said.
“We think earnings and excess capital are undervalued at a buyback-adjusted medium term price-earnings of 6-7x; upgrade to Buy.”
UBS expects higher dividend yield, share buybacks
RBS is targeting earnings per share (EPS) of 34p in 2020 and while UBS is “more cautious” with its estimate of 28p, it expects £5bn in share buybacks to the end of 2021 to take the stock to 6.5 times earnings.
UBS estimates a dividend yield of 3.4% in 2018, rising to 5.0% in 2020, along with buybacks and special dividends to reduce overcapitalisation.
In 2019, UBS expects RBS to ask shareholders for approval to repurchase stock direct from the UK government, reducing the overhang, increasing index weights and delivering EPS accretion.
The government sold 925mln of its shares in RBS in June, reducing its stake to 62.4% from 70.1%.
Risk of no-deal Brexit
With any company, there are of course risks, and a no-deal Brexit scenario is a major one facing RBS.
“If negotiations fail we would expect pressure from margins (Bank of England to cut rates and restart quantitative easing), loan losses (lower house prices, weaker macro-economic assumptions under IFRS 9) and higher risk-weighted assets density,” UBS said.
“We don't kid ourselves that discounted valuations would provide protection. But a no-deal Brexit is also not our base case given significant apparent risks to financial stability for both sides of the negotiating table: we see room for UK domestic bank exposure in any portfolio.”