Lloyds (LSE: LLOY) is one of the most discussed and analysed companies in the UK, but despite all the chatter the shares always seem to be undervalued.
It seems as if most investors are still wary of Lloyds, and considering its history, you can see why. With so much uncertainty surrounding the UK economy post-Brexit, it makes sense for investors to avoid those companies with the most unclear outlooks and the last thing investors want is a repeat of Lloyds’ 2009 experience.
Still, sentiment towards the bank is slowly improving and if things continue to go well, sentiment could return to pre-Brexit levels this year. For example, this time last year City analysts were forecasting 2017 earnings per share of 7.8p. After Brexit, estimates were quickly slashed, hitting a low of 6.5p in August. However, over the past three months, as it has become clear that Brexit is not the end of the world and analysts have increased their earnings targets back to an average of 7p.
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If economic data and Lloyds’ earnings continue to surprise to the upside, it’s not unreasonable to suggest that consensus earnings estimates could move back up to 7.8p as the year progresses.
Higher earnings?
There’s even a chance Lloyds could earn more than 7.8p for the year thanks to its acquisition of credit card provider MBNA. Higher City forecasts already reflect this acquisition which, based on last year’s figures will add £166m of income to Lloyds’ bottom line. If you combine both a return to pre-Brexit earnings, as well as the boost from MBNA, earnings per share of 8p or more for the bank is easily justifiable.
Based on current consensus earnings estimates of 7p, shares in Lloyds are trading at a forward P/E of 9.8, which looks cheap. Compared to the rest of the UK banking sector, the firm is trading at a discount. The wider sector trades at a forward P/E of 10.4.
Premium company
Arguably, Lloyds deserves a higher valuation than its industry peers. City analysts believe the firm can generate a consistent return on tangible equity of 13% per annum over the next few years, far above that of its banking rivals, which are struggling to break above 10% (or less). But if shares in Lloyds do pick up trade at a valuation in line with the sector average, they could trade at 72.8p, 6% higher than current levels.
If City forecasts return to previous highs or hit 8p, shares in the bank could be worth as much as 83p. Throw in Lloyds’ dividend payout as well, and investors could be looking at a total return of 27% over the next 12 months.
The bottom line
So overall, as sentiment towards Lloyds improves, shares in the bank could rally up to and above 80p within the next year. If you include dividends, investors could be set for a gain of 27% as Lloyds’ recovery phase nears its completion.
