The half-year results released by Lloyds (LSE: LLOY) on Thursday showed that the company is making progress despite legacy issues. For example, it has been able to grow profit by 4% versus the same period of the prior year. With Neil Woodford recently purchasing the company and its valuation continuing to be low, now could be the perfect time to buy it for the long run.
Legacy issues
As with a number of its sector peers, Lloyds continues to experience challenges caused by legacy issues. For example, it has now set aside a further £1bn to cover the cost of insurance mis-selling and the treatment of mortgage customers. Of this £1bn, around 70% will cover payment protection insurance (PPI) claims, while the remainder is set to be used to repay almost 600,000 mortgage customers.
While disappointing, the provision is not wholly unexpected. In the long run, such costs are likely to gradually fall and leave the bank with greater capital to reinvest or pay out to investors as a higher dividend.
Improving performance
Despite its legacy issues, Lloyds continues to make progress as a business. It has increased statutory profit by 4% to £2.5bn, while underlying profit is 8% higher at £4.5bn. This shows that once the PPI scandal and compensation payments to small business owners and mortgage customers are over, there could be a strong business in place.
Part of the reason for the company’s improving profitability is its ability to continually cut costs. While a number of other UK banking companies have seen their operating costs rise since the credit crunch, Lloyds has been able to reduce them in order to generate a sector-leading cost-to-income ratio of 45.8%. As well as this, its 4% increase in total income shows that it is benefitting from a rising top line too. With forecasts for the full year being maintained and further increases in loans and advances expected following the acquisition of MBNA, the outlook for the company is relatively bright.
Investment potential
The improved financial performance from Lloyds means that a higher dividend is becoming a reality. Dividends per share were increased by 18% for the first half of the year. This is in line with plans to raise them by 53% for the full year. This puts the company’s shares on a forward dividend yield of 5.8%, which is more than twice the current rate of inflation.
Although a fall in earnings of 2% is forecast for next year, a wide margin of safety suggests that the risk/reward ratio remains favourable. Lloyds has a price-to-earnings (P/E) ratio of just 9.4, which indicates that the potential for capital growth remains high. Certainly, more legacy issues seem likely over the coming years. But with improving performance, a high yield, wide margin of safety and sound strategy, now could be the perfect time to buy it for the long term.
