Lloyds Banking fan's new forecast

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Lloyds Banking fan's new forecast
Lloyds (LLOY) has had a rotten start to the year, although, to be fair, no worse than the FTSE All-Share (ASX) index. Both are down a little less than 5%. But this is the year chancellor George Osborne sells off what's left of the government's stake in the high street lender. Things had better improve.

HM Treasury only makes a profit on its Lloyds stake at 73.6p, and has previously instructed its brokers not to sell below that price. It was thought that a £2 billion retail share offer could come as early as March, although thinking now is it may be delayed until after Lloyds' first-quarter results on 28 April.

Tom Elliott, international investment strategist at deVere, believes the lender will do well in 2016, though. In a recent video interview with Interactive Investor, he said investors underestimate the political will in the Treasury to see the government's stake in Lloyds sold at a reasonable price and as a successful investment.

Sure, there are issues with a heavy reliance on UK residential home loans, and regulators are an ever-present threat. We're hearing about an investigation into rigging of the UK gilts market, too. But the prospective dividend yield remains attractive, and returns are impressive, even after a downgrade by Barclays.

The broker has revisited forecasts, reducing underlying earnings estimates by 5% to 7.6p for 2016, down from a predicted 8.2p in 2015, and 9% to 8.2p for next year. "We see slightly less net interest margin expansion together with a weaker outlook on non interest income," it explains.

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Income seekers will also get less if Barclays is right. Lloyds is tipped to pay 3.8p in dividends this year, down from an estimated 2.3p in 2015. In 2017 it could be 4.9p. At the current share price, that still works out at a forward yield of 5.5% for this calendar year.

Lloyds still a favourite at Barclays

We reported in August how the broker predicted that Lloyds shareholders could expect a windfall over the next few years. Barclays still thinks the bank could return close to 40% of its market capitalisation over the next four years. That's £19 billion, or 27p per share.

And Lloyds remains Barclays' preferred major UK bank.

"It's not new news that Lloyds is at least a solid mid-teens RoTE [return on tangible equity] business with the potential to return a significant amount of capital to shareholders, yet this isn't reflected in its current valuation.

"The shares are on a price to book premium to the sector but not as big as the RoTE premium. They are also on a slight PE [price/earnings] discount on solid earnings and neither factors in our expectation that close to 40% of the market cap can be returned to shareholders."

Barclays thinks that recent clarification from the Bank of England on the capital framework for UK banks and Basel IV, suggest a strong case for Lloyds to begin a more significant capital return. Watch out for a special dividend, possibly announced alongside full-year results on 25 February, says the broker.

A gentle recovery in earnings

Despite the softer profit outlook for 2016, net interest margin is seen as stable and credit quality should improve. That should allow a "gentle recovery" in earnings next year, but with RoTE rising to 17% on a Common Equity Tier 1 (CET1) ratio - a measure of financial strength - of 13% in 2018.

"We see good prospects for share price outperformance," says Barclays. "The UK government also aims to fully exit its remaining stake in 1H16. We reduce our price target 10% to 95p but, with more than 30% upside potential, we reiterate our 'overweight' rating.

"Our fundamental price to book approach suggests a 92p fair value for Lloyds with additional capital distributions increasing this by as much as 10p, suggesting 30-43% upside potential to the current share price.

"Although the 1.2x price to tangible book multiple is 30% above the sector, we do not believe that it fully factors in Lloyds' already-superior RoTE."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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