Analysts have refused to get carried away with their outlook for Lloyds, despite the bank revealing a 26 per cent increase in profits from last year.
There appeared to be plenty to cheer from the bank’s annual results, released on Wednesday – aside from the increase in profits from £3.5bn in 2017 to £4.4bn in 2018, its dividend rose 5 per cent to 3.21 pence and it announced a further £1.75bn in share buybacks.
Market reaction was positive, with shares rising by around 5 per cent during the course of the day.
Justin Cooper, chief executive officer of Link Market Services, said the results showed “the banks are back as dividend powerhouses”.
“Their balance sheets are strong and they have become hugely cash generative,” he added. “That cash is making its way back to shareholders.”
“Lloyds is already distributing more in dividends to shareholders than it did before the financial crisis. The banks now make up 12 per cent of UK dividends from a low point of 7 per cent after the financial crisis. Their recovery means UK investors are becoming less dependent on oil and mining dividends to provide their income.”
Performance of stock since pre-crisis peak
Source: FE Analytics
However, Graham Spooner, investment research analyst at The Share Centre, was more measured, describing the results as “a mixed bag”, adding that while profits saw a substantial increase, they were still below market expectations.
“The group, like most of its peers, was hit by the market weakness over Q4, but unlike some there was a more confident overall tone,” he said.
Hargreaves Lansdown's Laith Khalaf (pictured) added that the big jump in profits can largely be explained by falling charges for payment protection insurance (PPI) compensation
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PPI has cost Lloyds £19bn to date, but with an August claims deadline, the senior analyst said this is a millstone the bank will be glad to leave behind.
“That means more cash can flow through to shareholders, which is precisely what we’re seeing with an increased dividend and share buyback programme to boot,” he continued.
“With such a high market share in key banking markets, the question is where Lloyds goes next. Part of Lloyds’ new strategy is to shuffle sideways into the financial planning and retirement market, and the bank is targeting one million new pension customers by the end of 2020.
“This is an ambitious target seeing as the government’s automatic enrolment programme has already prompted a round of company pension switches. However, the strategy makes sense to give Lloyds some diversification from its core banking activities, and allow it to spread its wings in another market.”
There appears to be plenty of room for upside as well. Lloyds is the dominant player in UK mortgages with about 21 per cent of market share, meaning its margins will be boosted by any increase in interest rates, which are still not far off record lows. Yet despite this growth potential and a dividend yield of 6 per cent, the shares trade at a forward P/E (price-to-earnings) ratio of just 7.65, with The Share Centre maintaining a “hold” rating towards the stock.
Valuations of UK banks
Source: Hargreaves Lansdown
Khalaf said there is, of course, an elephant in the room.
“Since taking over the reins in 2011, [António] Horta Osório has presided over a bank which has swung from an annual loss of £260m to a profit of £4.4bn. The share price meanwhile is still around the same level as when he became chief executive.
Performance of stock (share price and total return) under CEO
Source: FE Analytics
“That’s because Lloyds is indelibly plugged into the UK economy and the shadow cast by Brexit means the bank’s shares are left out in the cold.”
However, he said it is this uncertainty that means there is still a buying opportunity in Lloyds for anyone brave enough to bet on a Brexit outcome that is better than the one being priced in by the market.
“If there’s a positive resolution to the current political uncertainty, we would expect the shares to rally,” the analyst added.
“That’s of course far from a given, but with a prospective yield of 6 per cent, shareholders are at least being paid to wait.”
There are 22 funds in the IA UK Equity Income sector who appear to be making this call, holding Lloyds in their top-10. One of these is L&G UK Equity Income, whose manager Stephen Message recently told FE Trustnet he cannot see the UK crashing out of the EU without striking some sort of deal.
“I think MPs at the moment are starting to see and starting to grapple with all the things that Theresa May has been grappling with for the past two and a half years,” he explained.
“It wouldn’t be a proper negotiation if all interested parties on various sides were not very vocal in what they wanted and that’s got to play out. So the risk to my view is that we crash out without a deal, but I don’t think that is going to happen.”
He added: “Broadly at the moment, I think one interest-rate rise is priced in. But in an environment where ‘no deal’ is taken off the table, then I think bond markets might start to focus on maybe two rate rises and maybe even three over time, because actually if you look at the underlying picture of the domestic economy, UK wage inflation is running north of 3 per cent, there are record levels of employment and the job market is tight.”
Even in the worst-case hard Brexit scenario, analysts do not think it will necessarily be catastrophic for the bank.
“Brexit looms big on the near-horizon, but is unlikely to dent Lloyds’ dividends in the year ahead,” said Cooper. “And if it is resolved without disruption to the economy, the banks look in very good shape.’’