Natwest’s stock plunged despite reporting decade-high profits

Investors are busily marking down UK bank stocks last week following their annual results. Barclays (BARC) suffered a 7 percent fall while Natwest Group (NWG) plunged 6%. What’s going on? Here we assess Natwest’s results and see if its fall is warranted.

Rate outlook is key

Bank stocks are deeply cyclical. The rise and fall of interest rates greatly affects their underlying profits. The biggest booster is the widening spread between the cost of capital and the rate that banks lend out. Typically, as interest rate soars bank profits rise because they earned more from the widening net interest spread.

Indeed, in the last quarter alone Natwest’s net interest income totalled £2.9 billion – an increase of 51% from the previous year. Total pre-tax income for the whole year (2022) totalled a staggering £5.1 billion, a rise of 33% from 2021. Return on tangible equity is at double-digits. You can see Natwest’s excellent results below:

Natwest’s full-year pre-tax profits rose to £5.1 billion, Source: Natwest plc

But despite presenting a solid set of results, investors marked down Natwest’s stock price, primarily because of two potential negative factors.

1. the base rate is now forecast to peak this year at a level not much higher than the current 4 percent. This means Natwest’s net interest income may stagnate in the next 12 months.
2. the economic headwind due from higher interest rates may lead to weaker demand and significant loan impairment in the future.

Both of which may could reduce Natwest’s profits.

As a result, investors are taking a more cautious tone.

The upside, however, is that Natwest will still be generating tons of profits in the foreseeable future. The £27 billion bank pays a generous 4.8% dividend yield; whilst valuation is undemanding (P/E of 7-8). Flushed with liquid resources, the bank is continuing a share buyback program. If the UK economy manages to ‘muddle through’ 2023, the bank may be a good bet amidst a volatile market.

Natwest’s bull trend: A consolidation or a change of trend?

Despite the recent setback, Natwest’s bull run may not be over.

Note this, since last October Natwest’s share price has gone up by nearly 50 percent. This is a significant advance in terms of market valuation. Overbought and in need of a pullback, perhaps traders are just taking profits after the annual results.

Technically, even after the latest gapped down, Natwest’s long-term uptrend appears intact. The pattern of lower reaction highs since 2020 remains in place. Therefore a multi-week retracement of its prior rally is perhaps a continuation of the long-term bull trend.

Should you, then, take advantage the recent gap down to buy? I would wait and see if that 280p former resistance – now support – will hold.

If it fails, the next support is at 250-260p. With a slew of bank earnings this week (HSBC, Standard Chartered and Lloyds (LON:LLOY)) the risk of a further decline is moderately high given the market’s negative reaction to Barclays and Natwest’s results last week.