Eight years after the Armageddon for banks that was the Financial Crisis, Lloyds (LSE: LLOY) is regarded as far and away the healthiest of the UK’s largest lenders. Despite cleaning up its balance sheet and de-risking operations earlier than rivals, shares of Lloyds still haven’t hit 100p since its last rights issue in 2009. Given the current pricing of shares at just shy of 66p, external issues and the bank’s sheer size, I don’t see Lloyds reaching the £1 threshold any time soon.
The main reason for my reticence is the bank’s current 0.98 price-to-book ratio. This means the shares have almost entirely priced-in Lloyds’ current assets. This is the polar opposite of rivals such as RBS and Barclays whose shares trade at less than half their book value. This makes sense given Lloyds’ reorientation towards being a healthy, domestic-facing lender is nearly complete while RBS and Barclays still have to shed billions of bad assets. So, if the shares are nearly fully priced, they will grow because either the company grows substantially or investors pile into Lloyds shares for other reasons.
Will growth happen?
Organic growth is very unlikely to happen due to the bank’s sheer size. Lloyds is already the UK’s largest retail bank and originates 25% of first-time-buyer mortgages, backs 20% of new businesses and has a substantial footprint in the slow growth credit card market. Realistically, it will find it difficult if not impossible to grow market share enough to significantly affect the top line. The company’s reliance on the UK economy could benefit the top line if domestic economic growth skyrocketed, but you’ll find few economists forecasting this any time in the near future as growth in Q1 ground to a minuscule 0.3% rate. Given shares would need to increase in value 50% from their current price to hit 100p, I don’t believe this will happen solely due to the bank growing organically.
Of course, investors could simply flock to the shares and drive up the price well beyond the current price-to-book ratio. Many small and mid-size ‘challenger’ banks seeking to disrupt the retail banking industry are priced well above their book value. Yet, this is unlikely to happen for Lloyds as it lacks the growth prospects of Metro Bank or Virgin Money, both of which are aggressively stealing market share from the big four lenders.
Looking ahead, the one instance I can see in which the shares increase in value substantially would be investors flocking to them for Lloyds’ dividend. This dividend currently returns 4.2% annually and is covered by underlying earnings if you strip out £4bn set aside for PPI misselling complaints. If PPI claims end by 2018, as some analysts are expecting, this will free up significant cash to be returned to shareholders.
However, analysts are expecting earnings per share to fall 9% over the next two years. If earnings continue to fall, dividends will be unlikely to continue rising precipitously. If dividends stay at their current level, they would only yield 2.75% on a 100p share price, and there remain much better options for income investors than that yield. At the end of the day, Lloyds shares are well priced for what the company is: a large, low-growth, safe domestic lender. Shares prices are unlikely to jump 50% any time soon unless Lloyds grows dramatically or the domestic economy booms.
