Why Lloyds is the bank to watch this results season

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Why Lloyds is the bank to watch this results season

For Lloyds Banking Group (LLOY) investors, annual results due next week from Britain's biggest lender can't come soon enough.

The shares remain where they were 12 months ago, despite a raft of City 'buyrecommendations and the promise of a dividend yielding above 7% over the next three years.

This sideways pattern for Lloyds shares has the potential to be broken next Wednesday when CEO António Horta-Osório sets out his long-awaited strategy plan for 2018-2020 alongside Q4 and full-year results.

With these earnings figures set to demonstrate the improved capital strength of the group, Lloyds is poised to announce an additional 1.2p a share in special distributions, most likely through a share buy-back.

Analysts at UBS believe that shares should be worth 85p, with Lloyds one of two stocks in UK banking with the potential to outperform in 2018. The other is Barclays (BARC).

That's partly because investors have become pre-occupied by uncertainty over Brexit talks, leaving domestic banks under-valued compared with those in the eurozone and especially HSBC (HSBA) and Standard Chartered (STAN).

In their preview of the upcoming banking results season, UBS analysts noted there was the opportunity for stocks to re-rate should the UK agree a transition agreement with Europe, delaying effective Brexit until about 2021.

Rising interest rates and stabilising mortgage spreads should also help boost net interest income, while Lloyds and Royal Bank of Scotland (RBS) are expected to provide investors with a degree of comfort around their ability to manage costs and mitigate top line pressure.

In next week's results, Horta-Osório will set out more details in this area by announcing plans for massive investment in technology in order to keep pace with digital banking trends.

Lloyds will also give a further update on its capital requirements going forward, with UBS expecting a CET1 ratio of 13.7%, which is well above its previous practice of paying dividends down to a level of 13%.

Provisions in previous results have been dominated by PPI, with Lloyds setting aside another £1 billion in the summer to take its running total to £18 billion.

UBS analysts think another £500 million will be necessary as industry estimates suggest that claims levels will remain in the region of 11,000 a week.

But the bank still believes capital generation at Lloyds will be sufficient to finance a dividend yield of 7%-9% between 2018 and 2021. On UBS numbers, Lloyds is trading at 8.7 times 2018 earnings estimates.

The investment bank's other pick in the UK banking sector is Barclays, with a target price of 225p. This is despite its earnings estimates being reduced by up to 10% due to weaker revenues in capital markets and the recent strength in sterling.

There should be more in the results from Barclays management on the company's capital distribution strategy. A 3p a share dividend is expected in annual figures next Thursday, with a projected yield of 2.6% for 2018 rising to 6.2% in 2020.

UBS said: "We expect significant interest in management's confidence around capital requirements and the timing and risks to a significant increase in capital distributions."

The analysts add that HSBC and Standard Chartered have a "fair amount to prove" at their results on Tuesday week and on February 27 respectively.

They said: "We expect a return to dividends for StanChart and another buyback at HSBC but consider both in the price. Without positive earnings revisions - or at least interest margin expansion - we see both at risk of a pullback."

At Royal Bank of Scotland, uncertainty over the scale of its settlement with the US Department of Justice over the mis-selling of residential mortgage-backed securities continues to cloud the investment case.

UBS has a 'neutral' recommendation but has increased its target price by 10p to 290p on the back of higher earnings estimates for 2019.

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