At first glance, Barclays (LSE: BARC) (NYSE: BCS.US) looks like a great play on the UK’s financial sector.
The group is currently trading at an appealing forward P/E of 11.7 and is set to support a dividend yield of 2.4% this year.
But there are several key reasons why investors should stay away.
No end in sight
The most concerning issue facing Barclays is the threat of legacy issues coming back to haunt the bank.
Even after paying £1.5bn to settle allegations that the bank manipulated foreign exchange markets last week, there are still numerous legal issues facing Barclays.
In fact, the sheer volume of legal matters facing Barclays has pushed one fund manager to declare the bank “uninvestable”. It’s just not possible to predict when the fines and mounting legal costs will come to an end.
Problem child
Barclays’ investment banking division is another reason WHY investors should avoid the bank as a whole.
Rising costs are squeezing the investment bank’s profitability, and better returns can be found elsewhere. Barclays’ investment bank produced a paltry 2.7% return on equity last year, down from 8.2% as reported the year before. The unit’s cost-income ratio — a measure of profitability — rose to 82% during 2014, from 77% as reported the year before.
That said, management is taking action to improve the investment bank’s deteriorating performance. Unit operating costs fell by 15% during the fourth quarter of last year, but it will take some time for these improvements to show through in results.
Non-core
Barclays’ non-core unit, or “bad bank” is being wound down, but the process is taking a long time. Barclays has used its bad bank to dump unwanted parts of its business including parts of its fixed income, commodities and trading operations as well as retail banking units in Spain, Italy, France and Portugal.
Over the past 24 months, Barclays has managed to reduce the value of risk-weighted assets in the bad bank from £110bn to about £75bn.
However, as the bank sells off non-core assets, it is having to take some losses, which are proving to be a drag on group profitability. Losses from Barclays’ bad bank division cost the group £1.2bn during 2014, around 22% of group pre-tax profit.
Lacklustre returns
If you want your portfolio to outperform, based on past performance, Barclays’ shares should be avoided.
Barclays has underperformed the FTSE 100 by a staggering 48% over the past five years, excluding dividends.
Changes ahead
Luckily, Barclays’ management has recognised all of the above issues facing the bank and the team is working hard to try and improve performance.
For example, Barclays’ new chairman, John McFarlane has emphasised the need to improve total shareholder returns while pushing the bank’s legal teams to resolve all outstanding legacy issues.
Meanwhile, the bank’s CEO Antony Jenkins has little patience for rising costs and under performing divisions. As a result, Jenkins has pledged to cut 7,000 investment bank jobs and cut the units share of group assets from 50% to 30%, giving the rest of the Barclays group more flexibility.
Will take time
It will take time for Barclays’ management to resolve all of the issues currently facing the bank.
And if you’re not prepared to wait for Barclays’ performance to improve, it could be time to turn your back on the bank.
