After nearly seven years, Lloyds’ (LSE: LLOY) management can finally claim that the bank’s recovery is drawing to a close.
And as Lloyds finishes settling its legacy issues, profits are recovering, the bank’s capital cushion is increasing, and return on equity — a measure of bank profitability — has hit a sector high. Lloyds reported an underlying first-half ROE of 16.2% and management is targeting at long-term ROE of 13.5% to 15%. Many of Lloyds’ larger peers have long-term ROE targets in the low teens.
What’s more, Lloyds’ capital cushion is above the level required by management and regulators. Specifically, Lloyds estimates that the minimum level of capital required for the business is around 12% (tier one equity ratio). At the end of the first-half the bank’s tier,one equity ratio was 13.3%.
Management has stated that Lloyds will return any excess capital to shareholders, and these cash returns should drive returns for investors.
Dividend giant
Current City figures suggest that Lloyds is a dividend giant in waiting. Management has stated that the bank plans to return “surplus capital” to investors during the next few years, and the group is targeting an ordinary dividend payout ratio of at least 50% of sustainable earnings.
As a result, City analysts believe that Lloyds could return £20bn to £25bn to shareholders over the next three years. Based on these figures, analysts have pencilled in a dividend payout of around 5.6p per share for 2017. Assuming that the market bids up the price of Lloyds’ shares to a dividend yield of 4.5%, the bank’s share price could hit 125p by 2017, excluding dividends.
When you include the dividends Lloyds is expected to pay between now and 2017, the potential total return is close to 140p per share.
For example, based on current City figures Lloyds is set to pay a dividend to shareholders of 2.5p per share during 2015 and 3.9p per share during 2016. A final dividend of 5.6p per share takes the total income received during the three-year period to 12p per share. Assuming Lloyds’ shares hit 125p by the end of 2017, the total return including dividends will be in the region of 137p, 84% above current levels — an annual return of more than 30%. Reinvesting dividends will only boost returns further.
Waiting to buy
Even though the figures suggest that Lloyds is set to return 85% during the next three years, I’m not buying just yet.
I’m planning to wait for the government’s retail share offering before taking a position as the offering is expected to be conducted at very favourable terms for private investors. Although the exact terms of the offering are yet to be announced, City analysts are currently expecting the shares to be sold at a 5% discount to the prevailing market price.
Also, there’s some speculation that a teaser offer in the form of a 10% bonus, up to the value of £200, will be made to investors who hold their allotted shares for a year.
