Over the past six months, shares in Lloyds Banking Group (LSE: LLOY) have lost a fifth of their value as wider market declines have weighed on the bank’s shares.
However, Lloyds’ underlying business continues to chug along nicely so should shareholders really be worried about the weak share price?
Time to worry?
A number of factors have weighed on Lloyds’ shares during the past few months. These factors include the sell-down of the government’s position in the bank, concerns about Lloyds’ ability to grow in an increasingly competitive market, and worries about the bank’s ability to increase payouts to investors.
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Nevertheless, despite these worries, Lloyds’ underlying figures continue to show improvement. Granted, Lloyds reported a weak-than-expected set of third quarter results (underlying pre-tax profit for the period fell to £2bn from £2.2bn a year ago) but this poor performance was a result of tougher trading conditions for the bank’s commercial arm and lower insurance income. Total income fell 4% to £4.2bn while pre-tax profit increased 28% year-on-year to £958m.
But it doesn’t make sense to analyse Lloyds based on just three months of trading and if you look at the bank’s performance over the nine months to the end of September, you get a much clearer picture of where the bank is heading.
Indeed, for the year to 30 September, Lloyds reported underlying profit of £6.4bn, up 6% year-on-year. Statutory profit before tax rose to £2.2bn, up 33% despite £1.9bn of additional PPI provisions. Net profit for the period rose 16% to £1.6bn.
When growth slows, look to dividends
All in all, Lloyds underlying business is performing well and based on the strong performance of the UK economy, it’s possible that Lloyds’ earnings could continue to expand next year. That said, City analysts believe that the bank’s pre-tax income is set to fall next year by around 3%, bringing to an end five years of growth.
However, while this downbeat forecast is concerning, it’s based on the assumption that regulators will clamp down on Lloyds’ exposure to the buy-to-let market. Analysts are also assuming that Lloyds’ customer growth will slow.
These risks are yet to materialise, so it’s difficult to assess how they will affect Lloyds’ earnings. Still, one thing we know for sure is that Lloyds is planning to ramp up its capital return to investors over the next few years. The bank is already sitting on more capital than regulators demand, and the group is targeting an ordinary dividend payout ratio of at least 50% of sustainable earnings.
Based on this objective, analysts have pencilled-in a dividend payout of around 5.6p per share for 2017. Assuming that the market bids up the price of Lloyds’ shares to a dividend yield of 4.5%, the bank’s share price could hit 125p by 2017, excluding dividends.
If you assume that Lloyds’ shares hit 125p by the end of 2017, that’s a possible total return including dividends of 137p, a gain of 99% from current levels. Reinvesting dividends will only boost returns further.
