Friday 18 August 2017

Anyone seeking to capitalise on BoI's share price rise must tread carefully

Laura Noonan

Laura Noonan

IN the murky world of the markets, there's often no point being right if no one else agrees with you.

After all, most investors can't single-handedly bid up the price of a stock. And even if they could, what would be the point if they couldn't eventually find another investor willing to buy shares at that higher price?

So, anyone who wants to get in on the action of Bank of Ireland's recent share price surge (up about 80pc from the start of the year) must ask themselves two distinct questions: is the share fundamentally undervalued? And if it is, will the market come round to that way of thinking and respond by bidding the share up?

The pure valuation question is undoubtedly the easiest one to answer. Bank of Ireland began 2012 with a share price of just under 9c, putting a market value of just over €2.7bn on the bank.

That €2.7bn compares with the bank's reported 'stockholder equity' of €6.5bn at the end June 2011 and also incorporates the €4.2bn of additional equity raised by the bank in July after the sale of new shares and a debt exchange.

A back-of-the-envelope calculation suggests, then, that there was a €7bn gulf between the market capitalisation of the bank at the start of January and the intrinsic value of what it was worth at the end of June and the gains it recorded since then.

The market is, of course, factoring in the impact of future losses that will erode shareholder value.

Impairments -- or the provisions that the bank is making for loans not being repaid -- remain the big watch word into 2012.

By the end of last June, Bank of Ireland had booked about €5bn of those impairments, including €841m in the most recent quarter.

How far is left to go on a loan portfolio that totalled €122bn at the end of June is open to debate, and depends largely on your view of where the Irish economy is going and the impact of a potential eurozone crisis.

But the the general view is that Bank of Ireland has the healthiest loan book of the bailed-out banks (admittedly no massive feat given the competition) and expectations are that future loan losses won't hit the "worst-case" scenario of €10.2bn in the stress tests.

The other major "risk factor" for Bank of Ireland -- deleveraging or asset sales -- has largely abated since the bank has just €1.4bn of assets left to sell off, so its exposure to a collapse in the market for banking assets is capped at that level.

All in, most analysts believe that Bank of Ireland's net asset value -- or the intrinsic value of one share -- will be comfortably above 20c by the end of 2013, once losses have worked their way through the system.

But does that mean the market will push the shares up to that price?

You'd have to think there'll be a discount for uncertainty for a while yet. Bank of Ireland investors have gotten seriously burned -- the bank's market capitalisation was €15.4bn at the end of 2007, most of that was lost.

Then there's the fact that Bank of Ireland's particular history and share register mean that the usual supply and demand dynamics don't always prevail.

Bondholders who agreed to swap their debt for equity last July come "into the money" once certain share levels are hit and may start selling -- something that will limit the potential for share price gains.

On the other hand, rallies are supported by the fact that the Government and strategic investors -- who together own about 50pc of the bank -- don't follow the usual shareholder mentality of selling down some of their shares and "profit taking" once the price rises.

The strategic investors are there for at least three years, the Government could sell out sooner but doesn't trade the stock on a daily/opportunistic basis.

That should mean, in theory, that once a rally starts, it lasts longer.

The share price performance so far this year does suggest that markets, generally, see potential in Bank of Ireland and are willing to act on that.

Shares rose about 80pc from their 2011 open to the 15c high hit on Friday, February 3.

Crucially, the price rises occurred on steadily increasing volumes -- in December, an average of 28 million shares a day were changing hands, in January, that average shot up to almost 40 million.

On the days with the biggest share price jumps, the volume has been highest -- close to 250 million shares were traded last Friday when the shares hit that magic 15c. Increasing prices on increasing volumes suggests serious momentum.

That doesn't mean it will continue, though. Already volumes have dropped back, and the price is back down in the mid-14c range.

Full-year results on February 20 will be carefully watched for signs of further loan book stress.

The eurozone crisis also looms large, and with it the spectre of a Greek default.

Even if that happened, you might still be right to believe that Bank of Ireland's fundamental value is above 15c.

But that would be cold comfort if the stock collapsed back down to 8c as investors rushed to indiscriminately dump banking stock from the so-called peripherals.

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