Qualiport

[ July 28, 2000 ]

Half-time at Lloyds TSB

By Maynard Paton (TMFMayn)

Carburton Street, London -- Continuing the banking sector's interim reporting season, Qualiport member Lloyds TSB (LSE: LLOY) announced their half-yearly results this morning. Although the current valuation of the bank appears attractive, the Qualiport is still not confident of making any purchase at present share price levels.

Here are the salient Lloyds TSB numbers.

                       Half year to 30th June      Change
                         2000        1999           (%)
                         (£m)        (£m)

Total Income            4,266        3,950           8
Operating expenses      1,876        1,694          11
Trading surplus         2,390        2,256           6
Bad debt provision        247          315         (22)
Profit before tax       2,068        1,853          12

Earnings per share (p)   26.8         24.2          11
Dividend per share (p)    9.3          8.1          15

As regular readers of this particular feature will be aware, I've already admitted to having a blind spot when it comes to banks. Although the mist is gradually beginning to clear, producing a concise interpretation of today's 39 pages of financial data is a rather Herculean task. Especially when the above numbers are complicated by various factors, namely:

• The purchase of Scottish Widows: The life and pensions business, acquired on 3rd March, contributed an overall pre-tax loss of £9m to the group.
  
  
• "Short-term fluctuations in investment returns": To "provide a clearer representation" of the investment profits generated by the acquired Scottish Widows business, long-term returns are now estimated to calculate a "smoothed" investment earnings picture. The "projected" amount is included within the trading profit of Lloyds, while the "fluctuation" (the actual return minus the projected return) is provided for at the pre-tax profit level. The difference in this interim period was a negative £59m, indicating Lloyds TSB experienced a short-term investment underperformance. A similar state of accounting affairs occurs at Independent Insurance Group (LSE: IIG).
  
  
• "Changes in the economic assumptions applied to the long-term assurance business": Following on from the Scottish Widows purchase, a review" of the "embedded value" contained within the group's Abbey Life and Lloyds TSB Life operations was carried out. Amongst other changes, revising the risk-adjusted discount gave Lloyds TSB a one-off credit of £127m in the period.
  
  
• Ongoing exceptional charges: Including the Scottish Widows integration, the total exceptional restructuring charge came to £74m. The total charge for the full year is to be £200m.

So on the face of it, there's a lot to consider. And in due course, I will peruse the numbers presented by Lloyds in more detail. But with investors' current attitudes towards the banking sector, there is a distinct possibility of "woods and trees" when looking at the financial nitty-gritty. As TMFPyad suggests in this feature concerning Alliance & Leicester (LSE: AL.), there is "a danger of overanalysing" when considering the current plight of the industry.

A stock market favour

When it comes to banks, the stock market has done ordinary investors a favour. The perplexing accounts can, to a certain extent, be put to one side. Anxiety over mortgage overcapacity, threats from the emergence of Internet banks and a generally more empowered customer base have all led to a widespread sell off within the banking sector. Valuations have plunged on all the fears. As we saw when we looked at Lloyds TSB last month, investors can now use the simple dividend yield measurement to judge the possible bargains on offer in this depressed sector.

I put forward this simple valuation philosophy when I contemplated "yielding to Lloyds".

An investment "bargain" is a company that:

• is large and well-established;
  
• has the prospect of producing a significant rise in dividend payments in years to come, and;
  
• has a prospective dividend yield equal to the return from Government bonds (gilts).

The risk-free return from 5-year Government bonds is 5.66%. Brokers had forecast a full-year dividend per share of 30.6p before today's results. Going by today's hike of the interim dividend payment, the anticipated 30.6p looks reasonably valid. The interim dividend was raised from 8.1p to 9.3p today, a rise of 15%. And a 15% hike in last year's total dividend payment (26.6p) would equate to the projected 30.6p figure.

On this measure, our bargain entry price for Lloyds TSB would be 30.6p/5.66% or 541p.

Topping up?

I certainly feel more comfortable evaluating the investment potential of Lloyds TSB by using the dividend yield. The cautious approach of focusing on dividends, rather than profits, is to specifically offset the inherent risk of investing in a business without having a sufficiently knowledgeable earnings interpretation.

With a 10% dividend hike in prospect for the year ended December 2001, coupled with ongoing dividend increases fuelled by greater cost-cutting, I'm sure basing any valuation assumptions on a steady dividend stream is the safest way forward for those unaware of every financial intricacy within this complex sector.

But from the above, at a current share price of 580p, I'm still not entirely convinced over any Lloyds TSB top-up at present levels. Although I stated last month that a Lloyds top up at 640p was "certainly tempting", I'm more inclined to reiterate this quotation from the same article:

"Should the Lloyds TSB share price drop to around 550p, all things (that is dividend forecasts and risk-free returns) being equal, investors would be in bargain basement territory."

I still consider that 550p is bargain basement territory for Lloyds TSB.

Another top-up contender

But as I deliberate on Lloyds TSB, another Qualiport company is homing into bargain basement territory. MMT Computing (LSE: MMT), a small IT consultancy, was purchased in April at 580p. After plunging to 475p and then soaring up to 680p, MMT shares have since spiralled back down to 582.5p. Taking a long-term view, nothing dramatically has changed at the company. Although there has been a delayed recovery after the Y2K slowdown, things at MMT now appear back to normal.

At 582.5p, MMT shares stand at little over 10 times forecast earnings for the year ended August 2001. Indeed, Tony Grellier, the Managing Director of MMT, indicated during this interview that the company's historic growth rate ("of at least 15%") was thought to be both "achievable" and "sustainable" in the future.

Top-up vote

So test the mood of top-up opinion, a poll for the weekend.

The Qualiport has £1,600 pounds in the kitty. With that money, should the portfolio:

1) buy Lloyds TSB at 550p
2) buy MMT at 580p
3) buy the shares of a different Qualiport company
4) buy the shares of a non-Qualiport company
5) keep the cash / don't know

Click here to vote. Monday will see a review of yesterday's annual results from Misys (LSE: MSY). Until then, have a great weekend.

Where Next?

• Revisit the Qualiport's Look at Lloyds
• Review TMFPyad's thoughts on Alliance and Leicester
• Or reflect on MMT Computing