Right now I’m looking at some of the most popular companies in the FTSE 100 to try and establish whether or not they have the potential to push profits up to levels not seen in the last few years.
Today I’m looking at Lloyds Banking Group PLC (LSE: LLOY) (NYSE: LYG.US) to ascertain if it can make £15bn in profit.
Have we been here before?
A great place to start assessing whether or not Lloyds can make £15bn in profit is to look at the company’s historic performance. However, as Lloyds has changed significantly over the past five or so years, by acquiring multiple competitors, trying to figure out how much profit the bank has made in the past is a tough task.
Nonetheless, after some digging it would appear that back during 2007, just before the financial crisis set in, the combined profit of Lloyds Bank and HBOS, both of which are now under the Lloyds Banking Group umbrella, was approximately £9bn. So, in theory, now these two banks are combined it should be easy for Lloyds Banking Group to hit my profit target of £15bn.
But what about the future?
That being said, although it’s easy to assume that, when combined, these two banks will find it easy to return to levels of profit seen before the financial crisis, in reality it won’t be that easy.
You see, back before the financial crisis began, banks were able to achieve abnormal levels of profit, as regulatory bodies were not as strict as they are today. As it turns out, a lack of strict regulation and the excessive levels of borrowing made by these banks in order to generate those abnormal levels of profit were two of the key factors that resulted in the near-collapse of the global banking system during 2008.
For example, a bank’s performance is usually measured in terms of return on equity — how much profit the bank makes based on shareholder equity. According to my calculations, the return on equity for Lloyds and HBOS during 2007 was approximately 23%. In comparison, Lloyds Banking Group’s most recently reported return on equity figure was around 13%.
Still, in terms of shareholder equity, Lloyds Banking Group and its components are about 20% bigger today than they were during 2007 . So, it should be easier for the bank to generate a higher level of profit with a lower return on equity.
Even so, Lloyds’ ability to hit my profitability target depends upon the health of the UK economy and interest rates — if interest rates go up, Lloyds’ net interest margin will expand. The net interest margin is the difference between the interest rate that Lloyds’ receives from the money that it lends out, and the rate of interest the bank pays on savings — a wider net interest margin means more profit.
City analysts believe that the bank’s pre-tax profit will be £7bn by 2015, although this is still a long way off my target.
Foolish summary
So overall, I feel that Lloyds cannot make £15bn profit.
