This is set to be the year when Lloyds (LSE: LLOY) is finally returned to full plc status. The government has been selling off its stake since the start of the year and is now no longer the bank’s biggest shareholder. In fact, the government may not even be a shareholder at all within a matter of months. Therefore, at this start of a new era, is the bank worth buying for the long term?
An improving business
Despite the government still owning a slice of Lloyds, the reality is that the bank has been healthy enough to stand on its own for several years. The current management team deserves credit for this, since it has put in place a strategy that has seen the company become more efficient, lower risk and increasingly efficient. The end result has been a return to profitability and a balance sheet which has performed relatively well in stress tests. Therefore, while the government’s share sale may be a significant moment on the one hand, on the other the bank hasn’t needed the government support for some time.
A changing landscape
However, the UK banking sector faces what could prove to be a difficult year. Brexit negotiations are expected to start at the end of the first quarter. This could see the uncertainty which has caused sterling to depreciate in recent months rise to a higher level. After all, nobody knows what a post-Brexit UK economy will look like. The pound could depreciate significantly, inflation could rise, interest rates could be forced upwards to counter price rises and a recession could ensue as businesses and individuals can no longer afford their debts.
Of course, this is just one of many scenarios. Equally, Brexit could be good news for the UK economy and free it up from the regulations and the anaemic growth of the EU. The point though, is that businesses, individuals and investors are averse to uncertainty. Therefore, the trading conditions which lie ahead for Lloyds could be less favourable than they have been in recent years.
Outlook
Evidence of the challenges ahead can be seen in Lloyds’ forecasts. It’s expected to post a fall in earnings of 6% in the current year, as well as next year. In theory, this could cause its shares to come under pressure. But in practice, Lloyds already has a wide margin of safety and so is unlikely to endure a significant share price fall. For example, it trades on a price-to-earnings (P/E) ratio of 10, which shows that it could rise substantially if investor confidence improves.
Should EU negotiations progress reasonably well, there’s a chance that this could happen. However, the bank’s share price is likely to remain volatile as uncertainty surrounding Brexit gradually builds. Due to its low valuation, improving operational performance and the lack of state aid though, Lloyds has huge appeal. It may not quite double in 2017, but it has the scope to do so over the medium term and remains a sound buy at the present time.
