The share price of CYBG PLC/IDR UNRESTR (ASX: CYB), or Clydesdale Bank, is rallying after the dual-listed UK-bank got upgraded by Morgans to reflect its acquisition of Virgin Money.
The stock jumped 1.9% to $6.07 yesterday compared to the 0.4% gain by the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index after the broker lifted its recommendation on the stock to "add" from "hold".
The move to merge with Virgin Money is almost a done deal as it has won the approval of the target's board and Morgans thinks it's a game changer for Clydesdale Bank.
"We believe the acquisition of VM [Virgin Money] significantly changes the investment thesis for CYB. CYB intends to rebrand all its businesses to Virgin Money, effectively making it the UK's new VM," said Morgans.
"We view this is a stronger brand than any of the brands currently in CYB's stable."
The upgraded shouldn't come as a surprise as I had flagged this outcome several weeks ago and there's more upside from the merger than just branding.
The combined balance sheet of the two challenger brands in the UK will allay worries about the impact of further payment protection insurance (PPI) compensation claims against Clydesdale Bank. These concerns have been one of the factors dragging on the bank's share price recently.
The £120 million in cost synergies should also translate to around a 13% increase to Clydesdale Bank's earnings per share (EPS) too. This is on top of other operational synergies such as changes to the funding mix from encouraging Virgin Money's customers to open a transaction account.
The merged group's EPS should get a further circa 5% uplift for every 10% of Virgin Money's customer base converting to a current account, added Morgans.
"CYB has said that the pro forma CET1 ratio of the combined group on day 1 is expected to be >12.0%," said the broker.
"We are forecasting the combined entity to deliver an underlying RoTE [return on tangible equity] of 13% in FY20. If such a RoTE is sustained, and with mid-single digit loan growth, we believe the combined entity can deliver a dividend payout ratio of ~60% over time."
This could translate to a 25 pence dividend payment to shareholders in the 2019 financial year ending in September. That would equate to a yield of around 7.4% based on the current exchange rate.
The payment of such a dividend would be a re-rating event for the stock, in my view. Up to now, income investors have ignored Clydesdale Bank as it pays a next-to-nothing dividend. A juicy and growing dividend will change all that.
Clydesdale Bank's path to a re-rating stands in contract to our banks such as Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC), which are facing legal and regulatory pressures at a time when the local housing market is falling.
Even regional banks like Bendigo and Adelaide Bank Ltd (ASX: BEN) are unlikely to escape reputational damage from the Banking Royal Commission.
For this reason, I have stayed underweight on the banks with the exception of Clydesdale Bank. This won't change in the short-term at least.
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