Anyone who owns shares in Lloyds Banking Group (LSE: LLOY) has had a rough year. Lloyds’ share price has fallen by more than 50% since the start of 2020. The coronavirus pandemic has triggered fears that banks could face a sharp rise in bad debt.
The bank’s business is totally focused on the UK, which is now officially in recession. We’re all hoping the UK will bounce back quickly. But the reality is that we don’t know how long it will take for economy to recover.
However, given what we do know, I think there are good reasons to believe Lloyds shares are too cheap at current levels.
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#1: the bad news is in the price
It’s important to remember markets always look forward. I believe Lloyds shares are already priced for bad news. In its half-year results at the end of July, Lloyds warned investors it’s planning for bad debts of around £5bn this year. That’s nearly four times more than the £1.3bn reported for 2019.
At this stage, Lloyds’ bad debt numbers are only estimates. Things may turn out better than this. Recent data from estate agents and car dealership certainly suggest consumers are starting to spend again.
However, my sums suggest that if Lloyds’ central forecasts are correct, the bank’s tangible net asset value would fall from 51.6p per share to around 44.5p per share. With the stock trading at just 28p as I write, I think that still leaves a healthy margin of safety for investors.
#2: Lloyds is still one of the best performers
Lloyds also has another attraction, in my view. It’s more profitable than UK-focused rivals such as NatWest Group (the new name for RBS). During the first half of the year, Lloyds generated a net interest margin — a measure of lending profitability — of 2.59%. The equivalent figure for NatWest Group was just 1.62%.
One reason for this is that Lloyds’ costs are lower. During the first half of the year, the bank’s costs accounted for 55.2% of its income, compared to 62.8% at NatWest Group. Lloyds’ lower costs should mean that profits bounce back more quickly.
Lloyds was the most profitable of the UK’s big high street banks before the coronavirus pandemic. I don’t think this will change. That should help the bank’s profits bounce back more quickly than at less profitable peers.
#3: Lloyds share price suggests 5.5% dividend yield
Banks were forced to suspend dividend payments by the UK regulator earlier this year. Several made it clear they could have paid, but had no choice but to comply.
The news was a bitter blow for income investors. But I’m pretty confident the dividend will return in 2021. Analysts’ forecasts suggest a payout of 1.58p per share next year, giving a forecast yield of 5.5%. That looks realistic to me. Despite this year’s disappointment, I believe Lloyds will remain a solid choice for income seekers,
Ultimately, sentiment towards the UK economy is dire at the moment. The Lloyds share price reflects this. But, at some point, things will improve. In my view, now’s probably a good time to buy some shares and tuck them away for the future. I don’t think they’ll get much cheaper than this.
