Shares in Lloyds Banking (LSE: LLOY) have been on a rough ride over the past five years. From a low of 32p in 2012 to a high of 89p, the shares have whipsawed with market sentiment as investors have struggled to regain confidence in the bank following its financial crisis troubles.
But while the market has struggled to regain confidence in Lloyds, during the past five years the bank’s underlying operations have undergone a dramatic turnaround. Today the business is nearly unrecognisable from what it was after the crisis bailout.
Indeed, last year Lloyds generated a mid-teens return on equity (a measure of bank profitability), reported that its Tier 1 capital ratio had increased above 13%, paid a dividend of 2.3p per share to investors and negotiated the acquisition of the MBNA credit card company from Bank of America.
A return to dealmaking should be enough of a signal to investors that Lloyds is back in business and has put the troubles of the past behind it.
Improving outlook
The City is finally starting to wake up to the fact that Lloyds is not the basket case it once was.
Specifically, analysts at investment bank Jefferies published a research note earlier this week in which they increased their target price for the bank from 67p to 82p, on the back of its improving operating performance.
25% upside?
Jefferies raised its fair value estimate for Lloyds to 82p based on its expectations that 2017 will be a profitable year for the group. While City consensus is calling for its earnings per share to fall by 4% during 2017 and 7% during 2018, Jefferies believes these forecasts are just too downbeat.
Instead, the US investment bank believes Lloyds’ margins will expand over the next two years thanks to rising interest rates and lower levels of bad debts.
It’s basing its predictions on the fact that mortgage rates are already rising. If the Bank of England decides to hike its key lending rate, margins could increase beyond the level Jefferies is predicting, which would mean Lloyds’ growth would significantly accelerate. The acquisition of MBNA will also help the bank.
MBNA boost
The acquisition is a great move by Lloyds’ management. The acquired business made net profits of £166m last year and is forecast to deliver a £650m boost to group revenues by 2019. Return on equity from it is expected to be in the region of 17%.
What’s more, Lloyds will be able to cut £100m from the cost base of both businesses, as it merges its existing credit card arm. Together both the Lloyds credit card business and that of MBNA will have a 26% share of the UK credit card market, giving Lloyds a substantial base from which to grow.
The bottom line
Overall, despite Lloyds’ progress over the past few years, the market continues to undervalue the business. If the group performs better than City expectations over the next 12 months, the shares could trade as high as 82p.
