Lloyds

Description

Lloyds Banking Group is a UK-focused financial services company, formed by the 2009 merger of Lloyds TSB and HBOS. The group, which can trace its heritage back to the seventeenth century, is primarily focused on retail and commercial banking. Lloyds is Britain’s largest mortgage provider and also offers a range of insurance, savings and investment products under the Scottish Widows brand.

In a modern ‘fiat money’ system, banks play a pivotal role in the economy through the creation of credit. When a banking system is functioning normally, credit creation fuels economic growth and the central bank monitors and influences the quantity of credit being created by adjusting base interest rates, as a tool for managing the economic cycle. In a benign economic environment, banks therefore offer leveraged exposure to economic growth.

Investment case summary

Having been a substantial investor in the UK banking industry in the mid-to-late 1990s, Neil Woodford’s view of the sector turned increasingly cautious in the run-up to the global financial crisis, due to increasing levels of leverage at the major British banks and broader macroeconomic concerns.

The extent of leverage was fully exposed during the crisis, with the UK banks proving extremely vulnerable to unfolding events. During this period, we spent a great deal of time and effort trying to understand the nature of the crisis and this helped frame a consistently cautious macroeconomic view in its aftermath, as the banks underwent the necessary and protracted process of rehabilitation – rebuilding capital and slowly crystallising the losses that had been incurred.

Importantly, that process now appears to be largely complete in the UK, as evidenced by the recent pick-up in bank lending activity. This is an important foundation for our renewed confidence in the UK economic outlook, which goes hand in hand with greater confidence in the case for investing in UK banks.

Specifically, we view Lloyds as a well-managed bank with a conservative approach to its balance sheet. Its valuation looks attractive in our view, and it has the ability to generate substantial capital in the years ahead, which will fuel a healthy and growing level of dividend.

Ask a question about our investment in Lloyds

Segmentation
Geography United Kingdom
Industry Financials
Themes UK domestic exposure

Source: Woodford

Share Price

Market Quotes by TradingView

Commentary

Strong set of results

Today Lloyds reported a strong set of interim results. The business strengthened its guidance for organic capital generation in 2018 – up to 200 basis points from 170 – 200 basis points previously. It also announced a 30 basis point decrease in its regulatory capital requirement.

Lloyds’ balance sheet remains very strong. CET1 capital stands at 14.5% of risk-weighted assets (RWAs) after subtracting planned dividends. This is in excess of the required level and, even with generous shareholder distributions, the bank holds surplus capital. For context, banks are required to hold a certain minimum level of such CET1 capital relative to their RWAs in order to ensure that their balance sheets are protected in case of unexpected economic and financial shocks.

The bank delivered an underlying return on tangible equity (ROTE) of 16.3%, making Lloyds the most profitable large UK bank in relative terms. For information, ROTE measures how efficient a bank is in generating profits on its net assets. Meanwhile, its underlying earnings per share increased by 45%, to c.3 pence and, so far, it has completed 75% of its £1bn share buyback.

Contrary to concerns expressed by some market participants, credit quality is showing no deterioration. The bank’s loan portfolio continues to perform well, reflecting its prudent approach to credit risk and a resilient UK economy. Overall, Lloyds is a market leading domestic bank with a strong balance sheet and surplus capital that is becoming more profitable with time and is able to return an increasing amount of capital to its shareholders. Therefore, the investment case remains strong and this recent set of results evidences continued strong execution from the business. Despite these ongoing attractions, we have been reducing the position in Lloyds in recent weeks, in order to take advantage of even more compelling valuation opportunities. For example, we have been keen to take advantage of material share price weakness in UK housebuilders, such as Barratt Developments, Bovis and Crest Nicholson.

Alex Correia
1 August 2018

Trading well

A strong set of Q1 results from Lloyds this morning, demonstrating that 2018 is off to a good start. The company reported an improvement in all key metrics and maintained guidance and strategic targets. Net interest income grew 8% year-on-year, driven by the MBNA acquisition and some margin expansion, even though growth in the mortgage loan book was relatively modest. Indeed, net interest margins are tracking slightly ahead of management guidance, due to declining funding costs and the benefit of the MBNA business on asset yields.

Growth in statutory profits was strong due to robust underlying profit growth and significant decreases in below the line conduct charges year-on-year. Capital generation remains robust and the company is currently tracking at the top end of the 170-200bps capital generation target. Consequently, capital grew by 20bps during the quarter, even after the dividend and the share buyback are considered (including these shareholder returns, capital grew by 50bps). The bank reiterated its expectation of a continuation of current benign macroeconomic conditions in the UK – asset quality remains strong, with no signs of a stress.

The valuation of this business remains compelling. As investors, we are receiving a c. 5% dividend yield and a c. 5% buyback and are thus being returned 10% of the market capitalisation on an annual basis. The bank is generating high returns on tangible equity (15.4% underlying) yet trades on a very modest multiple of tangible book (1.2x 2019E).  A price/earnings ratio of 8.5x 2019 estimated earnings is, in our view, an undemanding multiple for a business that is growing underlying profitability at mid-to-high single digits per annum. The bank continues to demonstrate steady improvement in all key metrics, yet the valuation multiples have yet to respond – this is very encouraging for future share price performance.

Alex Correia
25 April 2018

Full year results for 2017

Full year results this morning from Lloyds, along with a strategic update, in what looks like a positive update pretty much across the board. Underlying profits are up 8% and the company has generated a return on tangible equity (ROTE) of 15.6%, which is above the top-end of the range laid out in its last strategy day in 2014.

The group generated nearly 2.5% of capital during 2017 and ended the year with a common equity tier 1 (CET1) ratio of 15.5% before shareholder returns. On that note, Lloyds is paying a total dividend of 3.05p for the year and has today announced a £1bn share buyback (which equates to a further 1.4p per share).

Asset quality remains high and impairments remain very low which, with Lloyds representing a key barometer for the health of the UK economy, points to the continuation of a benign backdrop.

Guidance for 2018 looks positive, in my view, with continued strong capital generation and net interest margins remaining strong. Meanwhile, Lloyds plans to invest more than £3bn in strategic initiatives, significantly more than the amount announced three years ago. This should further bolster the outlook for long-term shareholder returns.

Alex Correia
21 February 2018

Neil's view

I am pleased to see the investment thesis playing out as I had anticipated. We can expect to see about a third of Lloyds’ market cap being returned to shareholders over the next three years the majority of it through dividends. Furthermore If you compare and contrast Lloyds and HSBC’s results this week you get a very interesting perspective on relative operational performance which is directly opposite to what their share prices have been doing and what valuations would imply.21 February 2018

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address 9400 Garsington Road, Oxford OX4 2HN.

Woodford Patient Capital Trust plc is incorporated in England and Wales, company number 09405653. Registered as an investment company under section 833 of the Companies Act 2006. Registered address Beaufort House, 51 New North Road, Exeter, EX4 4EP.

© 2019 Woodford Investment Management Ltd.
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