Lloyds(LSE: LLOY) (NYSE: LYG.US)is a decent banking business whose shares are overvalued by at least 20%, in my view. Heres why.
Capital Strength
Lloyds capital strength will be severely tested by the Bank of England in December, after Lloydsnarrowly passed a stress test from European regulators in November. The state-owned bank was the worst performer among the British banks, according to results announced on Sunday.
Twenty-five eurozone banks flunked financial-health exams designed to measure their ability to withstand another economic crisis, falling short of minimum levels of capital by a total of 24.62 billion ($31.17 billion), the Wall Street Journal reported on Sunday.
Based on several trading metrics, the shares of Lloyds are the most expensive in the UK banking universe right now. Sovereign risk is alive and well, as testified by plunging bond prices in Europes periphery earlier this month. According to the European Central Bank and the European Banking Authority, 40% of the banks that failed the stress test are from Italy, the third largest economy in Europe ouch!
Performance
The banks stock performance reads -3% in 2014, but the shares recouped almost 4% of value last week. Lloyds stock rose in the wake of press reports suggesting that the bank would cut about 9,000 jobs in the next three years. Thats 10% of its global workforce.
Lloyds may become more efficient but is not a compelling buy at this level, however. In fact, its stock is more likely to plunge to 60p than to rise to 90p, in my opinion. It currently trades at 75p. Third-quarter results, which are due on Tuesday, wont move the needle, in my view.
A Few Other Problems
Are dividend projections safe? No, they are not.
Bullish forecasts for earnings and dividends seem to underestimate the possible impact of a low-growth environment on the banks bottom line. Lloyds is mainly a UK bank operating in the retail sector. Along with a strong pound, the economic recovery in the UK is jeopardised by a growth rate that is just acceptable and is not as high as it should be for a country whose fiscal deficit remains highly problematic.
Addressing historic conduct issues continued to be a key theme in UK retail banks, Lloyds said in its 2014 half-year results. This is one of the biggest issues weighing on the valuation of the entire banking industry in the UK and its not reflected in the valuation of Lloyds stock. One could easily argue that the shares ofBarclaysandRBSare much cheaper based on this risk metric.
What else? First, the pressure will inevitably build up on the stock when the UK government decides to get rid of its stake. Second, the assets base of Lloyds is shrinking, but there are fewer assets to sell.
Lloyds may be perceived as a bond-like investment one offering a stellar forward yield that today could be bought at a significant discount to its fair value. But based on the banks assets base, at 75p a share, Lloyds stock doesnt factor in the risks associated to the tough macroeconomic and regulatory environment in which the bank operates.
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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
