Could this FTSE 250 stock be the next Rolls-Royce?

Close Brothers Group (LSE:CBG), the FTSE 250 merchant banking group, has seen its share price plunge 73% since November 2023. Such a dismal performance isn’t surprising given the regulatory and legal challenges that it — and others in the industry in which it operates — is currently facing.

In January, the Financial Conduct Authority (FCA) announced an investigation into the historical mis-selling of car finance. It’s alleged that discretionary commission arrangements were in place that encouraged motor dealers to sell finance at higher interest rates.

In October, the Court of Appeal ruled that the consent of customers should’ve been obtained before a broker received any type of commission payment. This has prompted fears that the FCA way widen the scope of its investigation.

Close Brothers is appealing the Court’s judgement.

What does this mean?

RBC estimates that the cost to the company could be compensation and fines of up to £640m.

Some have pointed out that this is over twice the group’s current (22 November) market cap of £309m. But this comparison is misleading. The company’s balance sheet at 31 March 2024 shows net assets of £1.84bn, so it should be able to survive even if the RBC prediction proves to be accurate.

However, to help shore up its finances, the company has sold its asset management business for £200m. The up-front cash payment of £172m provides a useful buffer should events take a turn for the worse.

And once this saga is resolved, it should be business as usual — albeit with much improved paperwork and increased transparency regarding commission payments.

If I invested now — and its share price were then to climb towards its all-time (March) high of £16.85 — I’d see a seven-fold increase in the value of my stake.

Sounds unlikely?

Well that’s by how much the Rolls-Royce share price has increased since October 2020.

The engineering technology group had to launch a £2bn rights issue, raise £1bn from a bond, and take on £2bn of new loans to survive the impact of the pandemic. Since then its share price has taken off and loyal shareholders have been rewarded with handsome paper profits.

Decision time

But I don’t want to invest at the moment.

Don’t get me wrong, I think the company will come through this crisis. I take comfort from that fact that its been around since 1878. Just think of the historical challenges — including two world wars and many financial meltdowns — that the group has survived.

And with all this bad news around, it’s easy to forget that the group’s profitable.

I missed out on the post-Covid Rolls-Royce share price rally and I could be making a similar mistake with Close Brothers.

However, I’m concerned that the FCA investigation has yet to run its course.

And the company could lose its legal appeal.

This makes me wonder whether there could be more bad news to come. Moody’s, the ratings agency, reckons the outcome could cost the motor finance industry up to £30bn. Given the uncertainty and the large sums involved, I’m going to sit on the sidelines and watch with interest how this drama unfolds.

The post Could this FTSE 250 stock be the next Rolls-Royce? appeared first on The Motley Fool UK.

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James Beard has positions in Rolls-Royce Plc. The Motley Fool UK has recommended Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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