Analysis of Lloyds Banking Group

2019 has been a pretty flat year for shares in Lloyds Banking Group (LSE: LLOY). The share price which has risen to 65p in the past nine months, it’s now languishing at around the 50p mark. That performance however is surprisingly better than its peers HSBC and Barclays as their share prices have fallen by 5% and 3% respectively so far this year. The banking industry has moved in the opposite direction to the FTSE 100 because it’s seen as more at risk from Brexit and a weakening economy. Banks are more cyclical and therefore share prices fall further when investors get nervous – as they are right now.

Opportunities and threats

Lloyds then is not alone in facing external threats. What potentially makes the problem more potent for the bank though is its focus on UK retail banking. More exposure to the UK right now is not seen as a positive because of the uncertainty that Brexit is causing – as reflected by the falling pound.

While Lloyds’ relatively simple retail banking business model is often its strength versus competitors that have more substantial international operations and investment banking divisions, right now that diversity is probably working the other way around. Even if for now at least the Lloyds share price is performing better if you look at the year to date. This is a situation that may well change, potentially very quickly.

While the threat from Brexit and economic conditions grows another risk appears to be finally subsiding. The deadline for PPI has now passed. It does mean in the short-term Lloyds has had to set aside even more money, between £1.2 to £1.8bn, to deal with the deluge of last-minute claims. But once those are processed the whole costly matter should be dealt with which will be a relief for management and shareholders. Those billions set aside for fines can now instead be used to pursue growth or be paid back to shareholders in the form of share buybacks or special dividends.  

Perhaps recognising the opportunity to expand into new areas the management has made the decision to move into financial planning and retirement. The strategic partnership with Schroders seems to be a first step in this new direction and it’s reckoned it will create a market leading wealth proposition – Schroders Personal Wealth.

Talking about the deal António Horta-Osório, Group Chief Executive of Lloyds, said:

“I am delighted to be announcing this exciting partnership with Schroders and the creation of a new market leading wealth management proposition. This provides a strong platform for growth and is a further step in the delivery of our strategic objectives.”

Lloyds will initially transfer £400 million of wealth related assets to Schroders’ UK wealth management business as part of the agreement, as well as transferring 49.9% of the JV to Schroders. There could well be more tie-ups in the future with Schroders, and with other wealth management and investment management companies, that have the scale to help Lloyds grow this part of the business.

There’s one other threat worth considering and that’s the rise of fintech and challenger banks. The latter seem to be struggling as evidenced by the wave of consolidations in the industry, so I don’t think they’re too much of a concern for investors and the potential for fintech has been around for a while without affecting the core earnings of the major banks. I’m sure the large banks have the firepower to take out startups that aggressively eat into their markets, wither by acquisition or by, increasing marketing spend on their own offerings. I don’t see these threats as likely to be damaging, but they are worth keeping an eye on, nonetheless.

Strengths and weaknesses

I honestly don’t see many weaknesses in Lloyds. I think it is extremely well managed and most of the triggers for a share price drop come from the external environment rather than from anything Lloyds is doing wrong itself.

On the other side of the coin I think the bank has strengths which investors should keep in mind. One of those is the bank’s effective cost control and market-leading cost:income ratio. This filters down into increased profitability which in turn means the bank can afford to raise the dividend, acquire businesses like it did when it bought the MBNA credit card business and spend on growth initiatives like the one highlighted with Schroder’s.

Along similar lines, a focus on digitalisation is also helping Lloyd’s keep costs down. Increasing digital capabilities is a fundamental part of the strategy of the bank. The key objectives for the bank are to cut costs and improve the customer experience. This means that spending on technology has increased by 24%. This is a good use of investment though in my opinion as banks grapple with legacy IT systems, making use of customer data and move customers to online banking platforms.

There has also been the introduction of robotics to undertake repetitive tasks. Innovations like these should make the bank on the one side more cost effective which is good for shareholders and allow it to be able to provide a better service for customers which likewise should be good for increasing customer loyalty. This should feed into the share price – maybe not immediately but definitely once the results start to show up in the income statement.

Share price and fundamentals

Looking at the share price, there are several indicators that it’s looking cheap. Firstly, the book value of 0.7x. Traditionally anything under 1 is considered to be good.

Then there’s the price-to-earnings-growth ratio which I recently calculated to be around 0.4. Anything below 0.7 is favoured by growth investors like Jim Slater, so I think Lloyds falls squarely into the bucket for a potential high-growth share. Alongside the growth potential, Lloyds also has a well-covered and growing dividend. Once the government stake in Lloyds was sold off, the opportunity to quickly grow the dividend has been seized and now the yield on offer is approaching 7%, partly due to the falling share price.

Conclusion

I recently bought shares in Lloyds Banking Group. I bought it with a long-term mindset and expect to hold the shares for at least five to ten years and I’ll probably add to my relatively modest holding when opportunities present themselves. This is because the group offers both a generous income and I think it’s clear from the ratios above that Lloyds also has significant growth potential.

I think at the current price the shares look cheap, but in the short term, there are some headwinds from factors beyond the control of Lloyds’ management. With that in mind I do believe now might be a good time to buy some of the shares and then add further when there is more clarity on Brexit and clearer signs that the UK economy and other major global economies such as the US and China are doing well.

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