While Lloyds Banking Group’s (LSE: LLOY) latest trading statement may have surpassed all broker expectations, the worrying state of the British economy would still encourage me to sell out of the bank straight away.
In a bright third-quarter update in late October, it declared that pre-tax profit surged 141% between July and September, to £1.95bn. This was thanks in no small part to the Black Horse bank avoiding additional provisions related to the PPI mis-selling scandal.
Too much risk
While impressive at face value, these brilliant numbers do not disguise the reality that Lloyds faces immense obstacles to keep profits growing.
Indeed, chief executive of Nationwide Joe Garner commented just last Friday: “We know that low wage growth and inflation are putting pressure on household budgets and we remain alert to signs of financial strains on consumers.”
These conditions resulted in a sharp rise in loan impairments in the six months to September, the building society said, to £59m from £37m a year earlier. Needless to say Lloyds and the rest of the retail banks face a similarly worrying situation.
Indeed, expectations of growing economic turbulence in the UK — and a subsequent adverse impact on Lloyds’ operations — is reflected in less-than-robust broker forecasts. Sure, the banking colossus is expected to see earnings detonate 166% in 2017. But the 5% reversal predicted for next year underlines the struggles Lloyds faces to generate sustained profits expansion.
Despite its forward P/E ratio of 8.6 times, I for one would not be tempted to invest right now.
Rather, with economic indicators likely to keep worsening as tense Brexit negotiations continue over the next year-and-a-half (and probably beyond); interest rates likely to remain at historically-low levels; and the Financial Ombudsman also clocking a resurgence in PPI claims in recent months, I reckon Lloyds’ share price remains in peril.
Up in smoke?
British American Tobacco (LSE: BATS) packs the sort of broad geographic footprint that Lloyds would love right now.
However, with lawmakers getting tough with ‘Big Tobacco’ across the world through smoking bans, the rollout of plain packaging requirements and so on, the once-formidable profits generation of yesteryear is by no means a foregone conclusion.
This is illustrated by the charge of the firm and its peers towards new technologies like e-cigarettes to generate future revenues as the allure of their traditional, addictive products fades. British American Tobacco announced late last month that it expects sales of its own next generation products, like its Vype vapour product, to hit £1bn next year and £5bn by 2022.
But with politicians across the globe also scrutinising the effects of e-cigs on users’ health (MPs in the UK launched an inquiry on this very issue in October), the Footsie giant could see these possible revenues drivers suffering from the same crushing regulatory action that have whacked sales of its tobacco brands.
The City is expecting to see earnings at the business rising 14% and 8% in 2017 and 2018 respectively. I do not believe a forward P/E ratio of 17.5 times fairly reflects the company’s uncertain long-term earnings outlook however. Instead, I would be more than happy to dump British American Tobacco today.
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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.