The One Factor That Could Drive This Bank Stock Higher

Poor Britain!

Have you heard?

It has the worst inflation in the G7, is hanging on to the Ashes contest by a thread, and its economy is barely larger than it was pre-COVID.

Surely this is a terrible time to get ‘exposure’ to the UK with a stock market ‘play’?

That’s the impression the mainstream might leave you with if you did nothing but tee off headlines.

Maybe it’s right.

But I’ll tell you about my experience with British bank Virgin Money UK [ASX:VUK]. It’s the sixth-largest lender in the United Kingdom.

I’m currently up 26% on my first buy here and about 9% on the second.

There could be plenty more coming up over the next few years. It’s an idea for you to follow.

Today’s Money Morning will use it to illustrate a broader point.

Equating the state of the economy with the share market is a mistake. It can distract you from opportunity.

When did I buy that first stake in Virgin Money?

November 2022.

Let me tell you the background here…

I’ve followed Virgin Money UK for — believe it or not — seven years before buying it.

Originally it was called Clydesdale Bank, then NAB span it out back in 2016.

For NAB, it was a legacy investment from the times when NAB was expanding globally.

The perception back in 2016 was that NAB turfed it back to the market cheap.

Certainly, an experienced writer and financial buff like Trevor Sykes saw opportunity in it at the time.

Then came the wild card — Brexit!

That scared the market…and CYB got dumped.

Then came a legacy scandal that caught up with the bank around misselling products…and regulatory fines.

Then the 2018 market sell down. Then later again the COVID crash.

And not to mention hundreds of millions in restructuring costs as the bank decided to go more ‘digital’ and rebrand under Virgin.

All in all, it’s been a volatile seven years for the bank!

I’ve kept a loose eye on it the whole time…and watched the stock mostly go sideways really.

However…

Around October 2022, the UK financial system got another scare.

There was panic in the City of London over the whiff that some pension funds might end up insolvent around interest rates and mismatched liabilities.

VUK got dumped again!

This time, I decided to pick it up ‘on the cheap’ after the UK financial system settled down.

One thing about higher interest rates is that it benefits banks more so than the ultra-low ones as we saw in the last 20 years.

As a share, VUK was ‘cheap’ on most metrics you care to name.

Pretty quickly, I found myself 30% up by the end of calendar year 2022. The British situation calmed down.

Was I chuffed?

It didn’t last long!

Take nothing for granted. By March, we had another financial scare…this time in the US!

My gain in VUK shrank back to diddly-squat as the market feared a credit crisis of some sort…now from the US.

At some point, I reasoned the fears were overblown…and bought some more shares.

I went too early, and quickly found myself down 10% on the second helping.

Was I worried?

Not really.

VUK is a UK bank.

What that had to do with a west coast US bank was not clear. The sell-off was based on fear.

In hindsight, there WAS no connection.

My homework on the stock also showed that it had a big capital buffer and was due a ‘stress test’ in the UK summer.

That was a juicy catalyst if it passed.

Why so?

Once (if) this was in the can, VUK could spend more money buying back its own shares.

That’s a positive for shareholders (usually).

VUK has also been growing its business…not a barnstormer but steady enough.

And it had mostly expensed the majority of restructuring costs…we’re talking tens of millions here, so future cash flows should flow back to shareholders more readily.

Then there was my intuition around the trading in the shares.

I detected a level of support in the market too…it seemed investors were accumulating on the sell-off.

There was nothing to do but wait to see what would happen…

And lo and behold, last week, VUK announced the Bank of England gave it the all clear.

Boom!

Look how the shares shot up:

Let me be clear on something at this point. I’m not pitching this stock at you to buy.

I’m saying there’s been an opportunity in a British stock despite the torrent of bad news out of Britain.

We can see similar stories all over the Aussie market now even though the headlines continually prattle on about recession, slowdowns etc.

However, one take away for you today is this…

There may be more in VUK over the medium term, but it depends on one factor.

British mortgages!

Yep, VUK is primarily a mortgage bank.

The recent uptick in the price is the market recognising the share was ‘oversold’ relative to the steady fundamentals of the business.

VUK could trend higher in future years…but only if it can grow its mortgage book.

Here’s the catch. That’s been flat lately.

British real estate has slowed down, like Australia’s and the US’s, in the last 12 months or more.

For VUK to grow earnings, it must grow its loan book.

So the thing to watch with VUK is if there’s any sign of that happening.

That’s the key factor for VUK to break out of its long-term trading range after all these years.

We can’t know the answer yet.

Keep watching the bank’s quarterly results to see how they go!

Best wishes,

Callum Newman,
Editor, Money Morning