It’s tempting to think that the TSB flotation provides investors with an opportunity to buy a chunk of Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) at an attractive discount.
After all, TSB’s loan and deposit books are essentially a cross-section of Lloyds’, so shouldn’t they offer similar performance?
Unfortunately not, in my opinion.
TSB’s small size and weak profits mean that investors will be reliant on the bank’s ability to grow its share of the mortgage and current account markets, if they are to see a return on their investment.
In reality, TSB is a growth investment, whereas Lloyds is an income buy:
| Lloyds | TSB | |
|---|---|---|
| Price/Book value | 1.4 | Approx. 0.8 |
| 2013 underlying profit | £6.2bn | £172m |
| 2013 underlying P/E | 9.1 | 7.4 |
| Dividend outlook | Dividend expected for 2014 financial year | Dividend expected for 2017 financial year |
| Number of branches | Approx. 2,900 | 631 |
Source: Company data, figures assume TSB floats at 255p
Although both banks appear to offer reasonable P/E ratios, last year’s profits were heavily distorted by one-off figures and don’t provide a realistic valuation, in my view.
I reckon that a more accurate way to value both banks is to look at their book values and dividend forecasts.
Book valuations
Lloyds shares already look fully valued: they currently trade at 1.4 times book value, which is higher than any other major UK high-street bank.
TSB shares are expected to trade at around 0.8 times book value. Given that TSB’s assets are essentially a cross-section of Lloyds’, without the legacy problems, this valuation does initially seem attractive.
However, I believe there are several good reasons for this discount.
Dividend outlook
Lloyds’ share price has been driven higher by hopes that the bank will get permission to restart dividend payments in 2014. Consensus forecasts currently suggest a payout of 1.4p this year, followed by 3.3p in 2015.
TSB, on the other hand, is not planning to declare a dividend until the 2017 financial year, meaning that shareholders will have to rely on hoped-for capital gains until then — hence the requirement for TSB shares to be priced below their book price.
Remember the Co-op?
A TSB share price of 255p will give the bank a market cap of around £1.275m. If you still think that looks cheap, then remember that that Lloyds’ previous plan for TSB was to sell it to the Co-Operative Bank, for just £750m.
Interestingly, a merger with Co-op could still be on the cards for TSB, whose independence and financial strength would make it an attractive partner.
A better bet than Lloyds or TSB?
In my view, Lloyds shares are already fully priced, and TSB shares are purely for growth investors.
