Arbuthnot Banking Group (LON:ARBB) is delivering the strong profit and franchise growth that had been promised, with underlying profits rising from £3.2m in 1H’17 to £4.2m in 1H’18. We now forecast 2019 adjusted pre-tax profits of £15m (statutory £13m) against £7.6m in 2017 (statutory £7m). Loans and deposits were both up 25% on 1H’17, driving a 25% increase in income. Costs rose 24%, with heavy investment in new business lines, in addition to volume-related cost growth. Impairments fell. The group is well funded (loans £1.1bn vs. deposits £1.5bn), strongly capitalised (Tier 1 ratio over 15%) and clearly attractive to new teams bringing incremental skills.
1H’18 results: 1H’18 continued the growth and investment of recent periods. Market competition saw redemptions slightly above expectations, but loans still grew 25% YoY. ABG will not compete where risk-adjusted returns do not meet hurdle rates. Loans are well secured, and the 1H’18 charge was just £208k.
Outlook: In addition to the strong organic growth, ABG should benefit from new teams delivering (i) commercial deposits (started 2H’17), (ii) asset-based lending (first loan May, pipeline £78m) and (iii) a new specialist bridging team, starting 1 August. We have increased 2019 costs by ca.£2m p.a. for these initiatives.
Valuation: The range of our capital deployed valuation methodologies is now £13.01 (DDM), £22.77 (sum-of-parts) and £26.78 (Gordon Growth Model). We believe the GGM best captures the profitability and growth of the business. The current share price is only around 2019E NAV (1,595p).
Risks: As with any bank, the key risk is credit. ABG’s existing business should see below-market volatility, and so the main risk lies in new lending. We believe management is cognizant of the risk and has historically been very conservative. Other risks include reputation, regulation and compliance.
Investment summary: ABG offers strong-franchise and continuing-business (normalised) profit growth. Its balance sheet strength gives it 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 around book value is an anomaly.
