Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) first-quarter results made pleasant reading this morning. The mainstream press may have gone negative with headlines such as ‘Lloyds Profits Down 32%’, but the real story was far more impressive.
Lloyds’ share price was up by 2.5% from the open, and as I write the bank’s shares are up by 4.7%. In this article I’m going to explain why Lloyds’ latest numbers suggest to me that there is more to come from this recovering bailout case.
1. It’s really profitable
Lloyds’ business model is based on straightforward UK high-street banking — and the bank’s profits suggest that this is a market that peers such as Barclays should pay closer attention to.
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Lloyds’ net interest margin rose to a sector-leading 2.32% during the first quarter of this year, continuing a steady rise from 1.96% during the same period of last year. This 18% increase corresponds nicely with the 22% increase in underlying profit Lloyds has delivered over the same period.
Although Lloyds’ reported profits fell during the first quarter, this was mainly due to restructuring costs and the additional costs associated with running TSB as a separate business. With TSB set to float this summer, these costs should soon fall.
2. Strong balance sheet
Another big problem area for UK banks has been the strength of their balance sheets. Barclays was forced to do a rights issue last year, while Royal Bank of Scotland Group still looks vulnerable.
There are no such concerns for Lloyds shareholders: the bank reported a fully loaded CET1 ratio (the key regulatory measure of capital strength) of 10.7% this morning, up from 10.3% at the end of last year, and substantially above the minimum requirement of 7%.
3. Earnings upgrade?
If Lloyds’ current progress continues, I believe the bank could deliver earnings substantially above the current consensus forecast of 6.9p per share in 2014.
I’ve calculated Lloyds’ underlying earnings per share over the trailing twelve months (April 2013 – March 2014) as 9.1p per share, placing Lloyds stock on an adjusted P/E rating of just 8.6, at the current share price of 78p.
This is only an approximate calculation, but it looks cheap to me, and the market’s reaction this morning suggests the City agrees. Throw in a prospective dividend yield of 1.9% in 2014 and 4.2% in 2015, and I believe Lloyds remains a buy.
