Virgin Money Earnings: Peak Margins, but Share Price Paints Too Bleak an Outlook

No-moat Virgin Money’s VUK first-half fiscal 2023 result was weaker than our expectations, largely on higher operating expenses and bad debts. Profit before bad debt expenses increased 5% on the second half of 2022, with revenue growth modestly outpacing expenses. Like in the first quarter, an improvement in net interest margins, or NIMs, and virtually flat loan balances drove the top line. The cost/income ratio of 51% in the first half was heading in the right direction, but guidance of 51%-52% for the full year is higher than the 50.5% we originally forecast. We now expect cost/income of about 51% for fiscal 2023, increasing our fiscal 2023 expense forecast by around 3.5%.

The higher operating costs and bad debts result in a 7% reduction in our profit forecasts in the short term, but the impact is less material on medium-term forecasts that already assumed cost-saving would be reinvested and the cost/income ratio would rise to around 54% over time. We reduce our fair value for Virgin Money by 4.5% to GBX 210, but increase our AUD fair value by 5% to AUD 4.00 at current exchange rates.

NIM improved 5 basis points to 1.91% on second-half fiscal 2022, and is up from 1.89% in the first quarter, with the bank benefiting from increasing low-cost retail customer deposits in the higher cash rate environment. Despite reaching 1.94% in the second quarter, we maintain our fiscal 2023 NIM forecast of 1.90%, in line with management’s target, which was tightened from 1.85% to 1.90% previously. Our long-term NIM forecast of 1.80% assumes competition for term deposits and new mortgages erodes further NIM uplift from higher cash rates, as will refinancing of wholesale funding.

An interim dividend of GBX 3.30 was declared with guidance of a 30% payout ratio for the full year maintained. The bank is in a strong capital position, so with a common equity Tier 1 ratio at 14.7%, well above management’s 13%-13.5% target range, future share buybacks are likely.