Lloyds (LSE:LLOY) shares are trading around 42p again. This tends to be something of a support level for the stock, meaning it has been here before and tends to bounce upwards.
To many investors, Lloyds shares look vastly undervalued. However, the stock hasn’t been pushing forward in recent months.
So what does this mean? Surely Lloyds must be one of the greatest bargains on the FTSE 100? Let’s take a closer look.
Near-term concerns
Novice investors and armchair pundits might assume that the higher interest rates go, the better it is for banks. However, this certainly isn’t the case.
Yes, there’s definitely a tailwind, and we can see this in the form of higher net interest margins and net interest income. In H1, net interest income rose 14% to £7bn versus £6.1bn last year. Underlying profit before impairments rose 16% to £4.7bn.
However, impairments are where the challenges lie. Monetary tightening of the levels we’re seeing today can lead to mass defaults, and this is what’s really spoking investors.
Lloyds impairments rose 76% to £662m in H1, and that was higher than the market anticipated. With the Bank of England (BoE) base rate likely to hit 6%, there will likely be more pain to come.
It’s also worth highlighting that monetary tightening works on a lag. In other words, due to fixed-term rates, higher interest rates haven’t reached all parts of the economy yet.
Lloyds is more exposed
Lloyds is more exposed than many of its peers to these headwinds. That’s because it’s not a universal bank and it’s operations are less diversified than its peers. And in this risk-off environment, Lloyds isn’t flavour of the year.
Can Lloyds survive?
Is there a future for Lloyds? In brief, yes, but it’s crucial to acknowledge the potential extent of the downside. According to its worst-case scenario, it anticipates expected credit losses of £10.1bn. But this would only materialise in an extremely dire situation. One would hope that the BoE would have foreseen such a possibility.
Although the possibility of defaults is worrying, it’s important to bear in mind that all UK banks recently passed a stress test. Depending on your perspective, Lloyds performed as the second-best. In the stress scenario, Lloyds’ CET1 would decline to 11.6%, placing it ahead of all banks except Nationwide.
Undervalued?
Yes, Lloyds appears to be undervalued, a conclusion drawn from a comparative assessment of valuations. With a price-to-earnings (P/E) ratio of 5.4 and a forward P/E of 5.7, Lloyds stands at a notable discount versus most peers. For example, HSBC trades at 6.7 times earnings, Standard Chartered at 10.1 times, and Bank of America at 8.9 times.
This perspective indicates Lloyds’ potential for share price growth. It also highlights that the market might not be fully appreciating its underlying strengths and growth prospects. However, waiting for a stock to actualise its fair value doesn’t happen overnight.
On this basis, Lloyds appears among the best value stocks on the FTSE 100, although peer Barclays is actually cheaper on several metrics.
