Tesco Bank deal prompts questions about Barclays' investor returns

Barclays PLC's recent deal to buy most of Tesco Personal Finance PLC's UK retail banking business has raised questions about its capacity to repurchase shares to boost its valuation.

The bank's low market value compared with domestic and global peers has drawn criticism from shareholders, who are waiting for an update on strategy and capital returns at Barclays' first investor day in a decade, taking place on Feb. 20.

The £600 million deal for Tesco's credit card, loans and savings operations would strengthen Barclays' UK arm and boost future earnings, yet it is a less attractive option for investors than share buybacks given the difference in valuation, equity analysts at JPMorgan said in a Feb. 9 note. At 0.6x price-to-tangible book, the acquired business is valued higher than Barclays, which is currently trading at 0.4x price-to-tangible book, they said.

The timing of the Tesco deal "is a surprise to the market" given that Barclays is yet to outline its capital distributions framework at the upcoming investor day and has not yet completed the sale of its German consumer finance business, the analysts said.

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Barclays has said the acquisition would not "materially impact the planned financial returns or distributions" for the group and would reduce its common equity Tier 1 (CET1) ratio by about 30 basis points upon completion, expected in the second half of 2024.

Even so, investors would "rightly question whether this is the best use of capital, with an enhanced buyback potentially preferable," given Barclays low valuation, Shore Capital analyst Gary Greenwood said in a Feb. 9. note.

More buybacks

Investors are pushing for more generous distributions from Barclays, and analysts see a sharp increase in buybacks as key to a meaningful increase in the share price, Reuters said in a Feb. 9 report, citing interviews with Barclays shareholders.

While there is support for Barclays' plan to grow its high-return UK operations to reduce the share of the lower-earning investment bank division, the rebalancing of the business mix would not happen soon enough to boost Barclays' share price over the near term, which would require higher capital returns, analysts at UBS have said. To change the narrative, Barclays must aim to return £10 billion to shareholders via dividends and buybacks in the next three years, the analysts said in a Feb. 9 note.

Although the Tesco deal is earnings accretive, it goes counter to a capital return thesis at least for now, the UBS analysts said. Yet the disposal of the German consumer business and tighter capital management of the investment bank balance sheet could give Barclays the extra cash to both expand buybacks and support acquisitions in future, they said.

'Incremental boost'

Barclays has said the Tesco retail bank acquisition would add £4.2 billion of gross credit card receivables and £4.1 billion of gross unsecured personal loans, together with some £6.7 billion in customer deposits, to its UK banking business. As of Sept. 30, 2023, Barclays UK had £172.3 billion loans and advances in its Personal Banking business and £9.6 billion of loans and advances at the credit card arm, Barclaycard Consumer UK, bank records show.

The deal would add incremental scale, revenue and profits to Barclays' already strong credit card business, Shore Capital's Greenwood said. The business being acquired has about 2,800 employees and made an adjusted operating profit of some £85 million in the 12 months to February 2023, which is equal to a little over 1% of Barclays total group profitability, Greenwood said.

On Feb. 20, Barclays is expected to unveil cost cuts and strategy improvements that would allow it to raise group return on tangible equity and boost capital distributions, leading to a higher market valuation.

Consensus analyst estimates suggest Barclays' return on equity (ROE) will be 8.15% in 2024 and 8.72% in 2025, compared with an expected ROE for HSBC Holdings PLC of 14.16% in 2024 and 12.99% in 2025, S&P Global Market Intelligence data shows. UK peers NatWest Group PLC and Lloyds Banking Group PLC are expected to post ROEs of 9.50% and 11.47% in 2024, respectively, which would increase to 10.19% for NatWest and 12.02% for Lloyds in 2025.

Barclays' payout ratio for 2023 is expected to stand at 27%, compared with 50% at HSBC, 40% at NatWest and 36% at Lloyds, according to Market Intelligence Dividend Forecasting data.