Since the Financial Crisis, increased regulation and onerous capital requirements have decreased the profitability of most major investment banks and called into question the viability of the universal banking model. Despite this,Barclays (LSE: BARC) has so far resisted calls to spin out its still-large investment bank and focus on more profitable and less-risky divisions. The high capital buffers and increased compliance costs now necessary to maintain the investment bank have caused return-on-equity (RoE) to lag far behind the credit card and retail banking divisions returns.
Q3 2015 Results by Division
Division | RoE % | Revenue m | Expenses m | Post- tax Profit m |
Barclaycard | 22.5 | 1292 | 507 | 353 |
Retail | 14.4 | 2180 | 1256 | 646 |
Africa | 9.7 | 861 | 543 | 90 |
Investment Bank | 5.2 | 1811 | 1459 | 182 |
Although the investment bank is still profitable, we see it requires resources thatfar outstrip its profits contributed to the group as a whole. Despite the fact that 2015 was a record year for mergers & acquisitions advisory fees, a dramatic fall in trading profits kept Barclays investment bank minimally profitable. Certainly, since the Financial Crisis, the investment bank has failed to pull its weight for Barclays and I dont see this changing any time soon.
While management is closing less-profitable branches in South East Asia and South America, it will still require significant capital reserves and costly compliance teams to maintain operations in the US, Asia and Europe. If Barclays were to focus on retail banking in the UK, Barclaycard and African retail banking, it could return capital to shareholders and unlock significant value thatthe investment bank is holding back.
Fuzzy logic?
Stagnation in spirits sales pushed Diageo (LSE: DGE) to divest over 1bn of sprawling wine and beer assets in the past year in order to focus on its core spirits business. While sales of American vineyards, Scottish golf resorts and Jamaican beers have allowed the company to refocus on brands such as Smirnoff and Johnnie Walker, it has stubbornly held onto brewer Guinness. Managements reasoning for this has been that selling more Guinness in Africa will provide an introduction to growth markets into whichCaptain Morgan and Crown Royal can follow. This logic is rather fuzzy to me, especially as spirits sales have been strong even in African markets where Guinness isnt a particularly big seller.
Furthermore, the recent $110bn tie-up between SABMiller and AB Inbev shows that a frothy beer market could lead the sale of Guinness to bring in upwards of 7bn, according to Bernstein. This cash could be put to good use paying off some of the companys 9bn in net debt or acquiring smaller, craft brands to which millennial drinkers are flocking. Net sales were down 2% year-on-year in the critical North American market, which accounts for 45% of operating profit, and Diageo desperately needs to work out how to bring youthful tipplers into the fold. Although Diageos beer sales are growing by double-digits in Africa, the region provides only 8% of group profits and I believe management would be better off concentrating on selling more of the high-margin premium spirits for which its known.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Barclays and Diageo. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.