Despite a rally from mid-February, Lloyds Banking Group (LSE: LLOY) shares are down 25% from their 52-week peak (inMay 2015) to 69p, so are we looking at a dog or a seriously overlooked bargain?
As the biggest traded share on the FTSE 100, it seems hard to believe that it could be the latter but I really think it is. Now, I have to come clean and tell you I thought the same when I bought some last September at 76p and then sat and watched them slide all the way to Februarys depths of 56p, so its possible I might be wrong. But I just cant see any faults in Lloyds fundamentals.
Lloyds comfortably exceeded the PRAs stress test thresholds last year, with a reported CET1 ratio of 12.8% and leverage ratio of 4.9%, dropping only to an estimated 9.5% and 3.9%, respectively, under the worst of the stress simulation. No liquidity problems then.
Stronger recovery
Lloyds came back from its bad old bailed-out days well ahead of fellow struggler Royal Bank of Scotland, and was able to convince the PRA to let it start paying dividends again in 2014. The yield that year was only1%, but 2015s rose to 3.8% (including a special payment of 0.5p on top of the ordinary 2.25p per share). And based on the banks progressive dividend policy, analysts are forecasting a yield of 6.3% for this year, followed by 7.4p in 2017 (covered 1.5 times by earnings).
On the P/E front, even the 10% fall in EPS fall predicted for this year would give a multiple of just nine, dropping slightly with a very small EPS rise on the cards for 2017. Thats way below the FTSEs long-term average of around 14, so why the undervaluation?
Lloyds flat earnings forecasts dont help, and only add to the uncertainty facing the banking sector as a whole. I dont think its a great problem, and I see the P/E undervaluing the shares even in the case of a few years of earnings going nowhere. But to institutions that hate uncertainty, it makes earnings visibility a bit cloudier and bank earnings are hard to understand at the best of times.
Misbehaviour!
Then theres that horrendous track record of banking sector naughtiness, with Lloyds part in the PPI mis-selling scandal especially egregious. But we really do seem to be getting past that, and at least the PPI business should hopefully be done and dusted by 2018. Again, its uncertainty, and once that goes, who knows?
The governments stake in the bank must be holding the share price back too, with some investors reluctant to buy at todays market price in the face of that big overhang when the final taxpayers stake is sold off. Add the general malaise affecting the whole financial sector and I see Lloyds low valuation as largely a sector characteristic rather than an accurate reflection of the bank itself. After all, Lloyds is on a lower P/E valuation than RBS, and a similar rating to HSBC and those two look far less attractive right now.
Best in class?
So I see Lloyds as the best bank in a sector thats suffering from very weak sentiment, but what might be the outer of value? Get that government stake sold off, and once we see healthier earnings forecasts I can see an upward rerating for Lloyds.
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Alan Oscroft owns shares in Lloyds Banking Group. The Motley Fool UK has recommended HSBC Holdings. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.