Improving Efficiency
Over the last handful of years, Lloyds (LSE: LLOY) (NYSE: LYG.US) has worked hard to improve its income streams and also reduce its cost base. Certainly, this has been a very difficult task, with the bank being a merged entity of Lloyds and HBOS, which were two major financial institutions, and as a result of this there have been severe job cuts as the new bank has attempted to become leaner and more efficient.
On this front, it has been hugely successful. Evidence of this can be seen in the bank’s cost:income ratio which, if its current strategy goes to plan, is forecast to reach just 45% by 2017. That’s extremely impressive and bodes well for the bank’s long-term profitability, since it means that Lloyds is now a highly profitable and very efficient institution.
Improving Financial Standing
Alongside a push for greater efficiency has been a focus on improving the bank’s financial standing and, on this front, Lloyds has also been successful. Certainly, there is more work for the bank to do, as shown in the recent Bank of England stress test where it had a capital ratio of 5% versus a requirement of 4.5%. However, Lloyds is making encouraging progress in this space, and the fact that it passed the Bank of England’s relatively challenging stress test bodes well for its long term viability as an investment.
Valuation
Although shares in Lloyds have risen by 40% in the last two years, they still trade on a very appealing valuation. As such, they could see their rating upgraded over the medium term, which would clearly be great news for the bank’s shareholders.
For example, Lloyds has a price to book (P/B) ratio of just 1.4 and this highlights just how cheap it is. That’s especially the case because asset write-downs are becoming increasingly less likely as the UK economy continues to improve, thereby providing the market with more confidence in Lloyds’ net asset value and allowing shares in the bank to trade at a greater multiple of it moving forward.
Leading Position
While there have been steps taken by the regulator to make it easier for consumers to switch bank accounts between different banks, only a very small proportion of customers actually do so. In fact, last year the total was just 1.1m in the UK. As such, Lloyds has a relatively stable and large customer base to which it can cross-sell its most profitable financial products, such as mortgages and credit cards. Therefore, while banking is changing in terms of moving online and into mobile, being a large incumbent such as Lloyds still makes for a sizeable advantage over sector peers.
Improving Outlook
The Eurozone’s quantitative easing programme may not be the silver bullet that solves the region’s problems, but it is still likely to improve the performance of the region over the next couple of years. And, it could also improve the European banking sector’s financial outlook, too, which would be a positive for UK banks such as Lloyds.
In addition, with the UK economy continuing to go from strength to strength, it’s a great place to do business at the present time. As a result of this, Lloyds could be in the midst of a purple patch and may deliver strong profitability in 2015 and beyond, thereby helping to push its share price higher.
