Has Lloyds Banking Group (LSE: LLOY) regained its crown as the FTSE 100’s top dividend stock?
Investors who’ve watched the bank’s share price falter over the last couple of years may be have mixed feelings about their stock, but I think the bank probably deserves more respect than it’s getting from the market.
Indeed, I believe Lloyds now ticks most of the boxes required for a first class income investment.
Under-rated quality
It’s easy to underestimate what Lloyds’ management has achieved since the bailed-out group was formed in January 2009. Lloyds now has the strongest balance sheet of any big bank, with a Common Equity Tier 1 (CET1) ratio of 13.8%.
It’s also highly profitable. Lloyds generated an underlying return on tangible equity (RoTE) of 14.1% last year. The equivalent figure for Royal Bank of Scotland Group was just 1.6%.
It’s important to understand what this impressive figure means for shareholders. In 2016, Lloyds generated booked misconduct charges of £2.1bn and spent £1.9bn acquiring MBNA’s UK credit card business. But the bank was still able to increase its ordinary dividend by 13% to 2.55p and pay a 0.5p per share special dividend.
Catalysts for growth
The main criticisms aimed at Lloyds are that as the UK’s largest mortgage lender, it’s too dependent on the housing market and has limited growth prospects.
According to the latest figures I could find, Lloyds has about a 24% share of the UK mortgage market, based on outstanding mortgage balances. This certainly suggests that further growth in terms of market share may be difficult.
Consensus forecasts for the bank’s profits reflect this cautious view. Earnings per share are expected to be broadly flat in 2017 and 2018. However, I believe there are two factors that could provide a boost to earnings over the next few years.
The first is last year’s acquisition of that MBNA business. This should make Lloyds one of the UK’s top two credit card companies by market share. The deal is expected to add 3% to earnings in the first full year following the acquisition, which should be 2018. It will also diversify Lloyds’ profits, although the bank will still be heavily dependent on the health of the UK economy.
Profits may also rise when PPI compensation claims finally come to an end. The government is currently consulting on plans to bar further claims after the end of June 2019. Lloyds spent £1bn on PPI claims in 2016. Removing this drain from the bank’s profits should be good news for shareholders.
An income buy?
Lloyds’ stock currently trades on a 2017 forecast P/E of 8.8 with a prospective yield of 6%. I don’t expect to see much in the way of growth for 2018, but this valuation suggests to me that the downside risk to the shares is limited.
Looking ahead to 2019 and beyond, I believe the bank’s earnings growth could surprise the market. In my opinion, Lloyds is one of the top dividend stocks in the FTSE 100, and remains a strong buy for income.
