Royal Mail (LSE: RMG) is up almost 20% in the last month of trade, while Lloyds (LSE: LLOY) has risen 13.5%. Here, I investigate whether it’d be reasonable to sell both stocks.
Lloyds
With Lloyds, you are betting on a rising dividend, mild capital appreciation and a balance sheet that may be the safest among the listed banks in the UK universe.
To start with, bullish dividend projections may end up being right if the bank continues to clean up its balance sheet, while interest rates rise at a faster pace than many economists predict over the next 30 months.
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According to market consensus estimates, the shares of of Lloyds should be able to yield 3.2%, 4.8% and 5.8% in 2015, 2016, and 2017, respectively.
If you are bearish, though, you are in good company.
A high forward yield signals two things: either Lloyds stock is grossly undervalued, which is unlikely to be the case right now, in my view, or market consensus is plainly wrong. The problem with Lloyds, as senior banking sources reminded me recently, is that its “return on tangible equity stinks”, while some key metrics based on book value point to downside of 20% or more.
Recent results showed that net income margin and earnings per share are rising, while return on equity and core capital ratios have improved. Still, the UK government has to get rid of its circa 20% stake in the bank over the next couple of years, which should put pressure on the shares. Questions will likely be raised about its dividend policy, too.
Royal Mail
It has been a great time to be invested in Royal Mail, with the stock up 23% so far this year, although this postal services group is faced with significant operational changes at a time when competitors from the digital world (such as Amazon) enter the field and seek partnerships, putting pressure on its core and more profitable parcels business.
Analysts have been bearish for some time, but I reckon Royal Mail may continue to surprise investors if relentless cost-cutting continues — at 523p, where the stock currently trades, it’s hard to say whether the shares offer more upside than downside, but they are surely a safer investment than those of Lloyds, in my opinion.
The stock trades 10% above the average price target from brokers, but some bullish estimates suggest it could reach 625p a share, which is a price target in line with its all-time high. Royal Mail has traded in the 388p-532p range over the last 52 weeks: based on fundamentals, trading multiples, its forward earnings growth trajectory — whose real appeal hinges on efficiency measures — and a flat forward yield at about 4%, which is covered by core cash flows.
All in, I believe Royal Mail offers less downside than Lloyds at this level.
