UK Edition
Questor: Lloyds now yields 4.4pc but there’s plenty of scope for capital growth on top
Lloyds Banking Group is an intriguing stock. It has, in Questor’s view, clearly been on the mend for the past few years, following its near collapse at the height of the financial crisis, but you would never know it from the share price.
Even after encouraging annual results earlier this week the shares are stuck at about 70p, a level they first reached, post-crisis at least, several years ago.
In this column’s view, investors’ continuing refusal to give the group the benefit of the doubt reflects a phenomenon we have often noted: that once a stock has really disappointed the market the negative sentiment can linger for years, long after the problems have been resolved and long after the executives around at the time have left.
In essence, then, Lloyds is a stock that in our view has been undervalued for a long time and after this week’s results, for the year to the end of December 2017, is even more so.
Of greatest importance for the Income Portfolio, of course, is the future of the dividend and Lloyds raised its full-year ordinary dividend from 2.55p per share to 3.05p.
On paper this is a 20pc increase. However, last year it paid a special of 0.5p a share on top of an ordinary dividend of 2.55p, for a total of 3.05p – the same as the one just announced.
You could therefore say that the 20pc increase is illusory. But we think the announcement is still positive, because a special by its nature can be dropped the following year without opprobrium (or worse) for the board.
Increasing the ordinary dividend, by contrast, suggests that the new figure is the base for following years – any reduction, other than as a result of truly exceptional circumstances, would be severely punished and the board would do almost anything to avoid it. If 3.05p is the minimum that investors can expect in future, it is not the maximum.
Lloyds also announced plans to buy back up to £1bn worth of its own shares (the total cost of the dividend, for comparison, is £2.2bn, and the firm’s market value is £50.3bn). Although readers are unlikely to take part in the buy-back programme, it is still a positive sign.
First, there is the concrete benefit of a reduction in the number of shares in issue, which means that profits attributable to each share rise, which can only be good for dividend prospects on a per-share basis.
Second, it is a sign of confidence, an indication that the board has enough belief in the group’s financial strength that it can afford to offload some capital. The board also stated clearly that it planned to increase the dividend.
“The group intends to maintain a progressive and sustainable ordinary dividend policy,” it said. “The rate of growth of the ordinary dividend will be decided by the board in light of circumstances at the time.”
It added, however: “Having grown very significantly in the last three years, the ordinary dividend is likely to grow at a more normalised rate [in future], while being supplementedby buy-backs or special dividends.”
The other aspect of the results that caught our eye was the plan to invest £3bn in digital banking and Lloyds’ wealth and insurance business.
Although it didn’t announce any new branch closures, Questor sees them as the inevitable result of the rise in online banking. A slimmed-down branch network would make Lloyds that much more efficient, another boost for shareholders (if not for those who depend on their local branch).
The new ordinary dividend equates to a yield of 4.4pc. This strikes us as a high figure for a stock likely to offer dividend growth, which further supports our belief that the shares are undervalued. The current yield is a little short of our target but we can expect the 5pc figure to be reached within the next couple of years.
Investec, the bank, expected a 5p dividend in 2018 but will revise its forecast in view of Lloyds’ use of buy-backs.
Should this 5p be paid but be distributed between dividend and buy-backs in the same proportion as this year, about 2:1, we can expect a cash dividend of about 3.3p, for a yield of about 4.8pc at the current share price. Investec expects further rises in the next two years.
All this makes the stock a sure hold for the Income Portfolio. But if we are right in our analysis there is also ample scope for capital growth, even in an environment of (gently) rising interest rates and bond yields.
For money outside the Income Portfolio, which is fully invested, the shares are a “strong buy”.
Questor says: buy
Ticker: LLOY
Share price at close: 69.18p