Stricken bank Barclays(LSE: BARC) and battered supermarket Tesco(LSE: TSCO) both started 2016 knowing they had a fight on their hands, and that was before the market meltdown. Current mayhem could make life harder for both of them. Can they withstand the pressure?
Barclays ended last year trading at 220p, but today you can buy it for 149p, a drop of 32%. Contagion is the major concern today, as investors look at "rock solid" Deutsche Bank and wonder which other banks could crack. Worryingly, Barclays and Deutsche have a few things in common, with both overhauling their investment banking operations as they battle to boost profitability in the face of falling revenues, and both cutting jobs to trim costs.
Banking profitability has been hit in part by tighter capital standards, but we still don't know whether they will work, as contingent convertible bonds, or "Cocos", seem to be causing as much harm as good right now. At least Barclays has lower exposure to China than Deutsche, which holds a 20% stake in brokerage Hua Xia. Barclays has further to go to comply with the Bank of England's Financial Policy Committee Core Tier 1 Equity requirements, with a capital cushion of 11.1% against the 12% required, but its strong showing in the 2015 stress tests is comforting.
In a reversal of the financial crisis, the big UK banks are more a symptom of current troubles, rather than the cause. The problem is that nobody can tell how bad this crisis will get. But in Barclays it has certainly thrown up a thrilling buying opportunity for brave investors, given today's valuation of just 9.1 times earnings and yield of 4.1%. When you look at brokers' target prices of 303p (Deutsche), 260p (JP Morgan) and 230p (HSBC) there is massive potential upside from today's 149p. Barclays could be a very rewarding trade, either way.
Crisis? What crisis? Tesco saw its share price dip below 140p in early January but it has since rebounded almost 30% and now trades at a dazzling 180p. That is still a way off its 52-week high of 237p, but has certainly reversed a lot of damage.
It hasn't all been good news, though, with suggestions last month that Tesco may be slapped with a £500m fine by the Serious Fraud Office over its £326m accounting black hole. Squeezing profit out of the company should become even harder after the Groceries Code Adjudicator ruled that Tesco had "seriously breached" rules covering treating suppliers fairly. Dave Lewis has admitted its focus on margins has damaged business relationship with suppliers and the company is now mending its ways. Its profit margin target was 5.2% as recently as 2014, the highest in the industry, but those days are long gone.
Tesco also has to tackle its looming debt mountain and aims to repay £1.4bn in the next few months, as the risk of default hits a new high. So why all the share price joy? The low expectations surrounding the stock made a 1.3% jump in like-for-like sales over Christmas look like a brave new world for the grocer, but Lewis has done well in airing the dirty laundry, boosting customer perceptions and sorting out the balance sheet. The supermarket sector is still too tough for me, but Tesco looks tastier than it has for years.
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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.