2018 hasn’t been the best year for shareholders in Lloyds Banking Group (LSE: LLOY) who might have been hoping for the share price to finally take off. Despite continued steady improvement in its profitability and growing capital returns to shareholders, Lloyds’ share price has lagged behind many of its peers since the start of the year.
Signs of weakness
Although recent results show the UK-focused bank is continuing to make good progress in lowering its cost structure and growing its revenues, there were signs of weakness emerging. The firm’s first quarter profits missed analysts’ expectations, raising concerns that the UK’s slowing economic growth would hold back earnings growth for the company.
Surprisingly, loan impairments more than doubled in the first quarter to £258m, while Lloyds booked another £90m charge relating to the mis-sold payment protection insurance issue that has dogged it for some years. Pre-tax profits increased by 23% to £1.60bn, against the consensus analyst forecast of £1.82bn.
Slowing growth
Looking ahead, the outlook for rising interest rates seems less promising than it did a year ago following weak economic data in recent months and a faster than expected fall in the rate of inflation, which forced the Bank of England to shelve a highly anticipated interest rate rise in May.
Without rising interest rates, Lloyds could be set to lose a major tailwind which has been driving its revenue growth. Net interest income accounts for roughly 70% of its total revenues, more than that of most large-cap banks, making Lloyds particularly vulnerable to the lower-for-longer interest rate environment.
Bullish catalysts
Still, its not all doom and gloom. Although slowing economic growth would likely hold back some future growth, on the back of the upcoming deadline for PPI claims in August 2019, a major headwind for earnings is set to disappear. PPI has so far cost the bank more than £18bn over the years, without which the bank would have been able to return far more cash to shareholders via dividends and share buybacks.
What’s more, the company is in a very different shape to where it was before the financial crisis. Risk controls have changed drastically, and the bank has refrained from the kind of risky banking practices that have got the business into trouble in the past.
Near-term earnings
Despite recent weak investor sentiment, City analysts remain sanguine about its near-term earnings outlook, with forecasts pointing towards a 63% increase in underlying earnings this year to 7.3p per share. As such, shares in Lloyds trade at just 8.6 times its expected earnings this year, a substantial discount to the market and its peers.
Valuations appear less attractive on a price-to-book measure. Shares in Lloyds trade at a 20% premium to its tangible net asset value per share of 52.3p, at a time when many UK-listed large-cap banks trade at a discount to tangible book value. Nevertheless, I reckon this should be justified because of the bank’s much stronger profitability, that is demonstrated by its underlying return on tangible equity (RoTE) ratio which stands at the highest of the big four UK banks — at 15.4%.
