We like a ballsy call, here on FT Alphaville, but what’s this? A “buy” note on Northern Rock, no less, from Merrill Lynch.
The stock is trading at 1.1x 2008e tangible book value for an expected RoE of 18%. Moreover, unlike US mortgage players where there remain doubts as to the book value from mark to market hits from revaluation of the sub-prime portfolios, Northern Rock is a prime lender with negligible intangible assets. If we were to consider Northern Rock as a closed book in run-off with a half-life of three years on its mortgage book/asset portfolio, this would suggest a fair present value of 872p on the stock, a 27% premium to the current share price. Our Price Objective is 913p, based on a target multiple of 9x 2008E.
The risks to our Price Objective are a more prolonged credit market closure than expected, and a macro downturn in the UK which would lead to higher provisions.
The risks to the author of this call, John-Paul Crutchley, have yet to crystallise.