There’s no doubting that among its peer group Lloyds (LSE: LLOY) is in by far the best shape. The group is actually paying out dividends, unlike RBS, and its statutory return on tangible equity (ROTE) of 8.9% is well above that posted by the likes of Barclays.
However, despite its 4.7% dividend yield and fast-improving profitability, I’m not any closer to buying the shares right now than I was two or three years ago.
This isn’t to take away from the fact that Lloyds is the best out of a bad bunch, but there are a few things that worry me about the black horse. One is its valuation. Its shares currently trade at 0.95 times book value, which is a fair price but one that leaves little upside re-rating potential in my eyes.
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This is because I see few growth prospects due to the group’s substantial market share in the UK, its only market. It has market share above 20% in retail banking and new mortgage issuance, leaving few opportunities to measurably and profitably grow, given the intense competition in the market.
Of course, Lloyds could still grow by simply maintaining market share if broader economic conditions kicked it up a notch. Unfortunately, there appear to be few catalysts for improved domestic economic growth in the short term.
That basically leaves acquisitions as the last method of growing the business. Here there are prospects to grow, such as the £1.9bn purchase of the MBNA credit card business and deal to purchase £19bn worth of pension assets from Zurich. However, while these are both growth areas for Lloyds, they are highly competitive sectors that are attracting many firms. This increases the risk of overpaying and means potentially lower margins as firms fight for the same customers, not to mention the long history of banks’ acquisitions going sideways.
So far, these are fairly small bets for the company and there’s no doubt Lloyds is on the right track with interest rates rising and costs falling. But with economic growth prospects tepid at best, Lloyds appears to me to be a fairly low-growth income option. Fine for some investors, but perhaps not those who want a bit more capital appreciation prospects from such a cyclical sector as banking.
Digging for cash
With that in mind, I’ve got my eye on mining royalty firm Anglo Pacific (LSE: APF). Full-year results released this morning showed the group is in great health with royalty income rising 90% year-on-year to £37.4m as commodity prices rebounded and management made good calls on which assets to allocate capital to.
Free cash flow for the year tripled to £41.5m, which allowed the group to pay down all outstanding debt, increase total dividends from 6p to 7p per share, and still end the year with £8.1m in cash. This puts Anglo Pacific shareholders in a great spot as they’re enjoying a 4.7% dividend yield but also considerable growth prospects as management intends to use fast-rising cash flows to invest in new assets.
And Anglo Pacific certainly doesn’t lack targets as miners, still scarred by the recent commodity crash, turn to outside financing like royalties firms to develop new projects. With growth potential, a very nice dividend and valuation of only 9 times earnings, I’d easily pick Anglo Pacific over Lloyds for my retirement fund.
