If this happens, I think the Lloyds share price could soar to 84p

I think this single event is all we’ll need for the Lloyds Banking Group (LON: LLOY) share price to take off.

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My colleague Royston Wild has examined the perils that might face Royal Bank of Scotland in the event of a post-Brexit slowdown, and I’d say he’s pretty much on the money all round.

The same is true for Lloyds Banking Group (LSE: LLOY). Despite a couple of blips upwards, Lloyds shares are down 22% over the past five years, and now find themselves languishing on a prospective P/E multiple of only a little over eight.

The revelation by the Office for National Statistics (ONS) that the UK economy shrank by 0.3% in November is not a good sign as we head into 2020. Had it been just a rogue month, I wouldn’t be concerned, but the ONS went on to say the economy is continuing to slow over the long term.

Talk of an interest rate cut is adding to the pessimism, as is Bank of England (BoE) governor Mark Carney’s suggestion that we might need some near-term stimulus.

Brexit

Lloyds has no real European business to lose after having refocused itself as a UK-centric retail bank. But the saving from that one risk opens it up very much to the risks from the UK economy. While a bank with international operations can more easily withstand a downturn in an individual economy, Lloyds could be badly hurt by a UK slump.

The bank has progressed well since the financial crisis, with a much healthier balance sheet and the ability to easily pass the BoE’s stress tests — it came through the last one in December nicely ahead of the required benchmarks. But it’s really open to a slowdown in UK demand, weakness in the mortgage market, and any accumulation of bad debts.

Yield and cover

The Lloyds dividend is expected to yield 5.6% this year, and it would be covered 2.1 times by earnings — and I’m happily pocketing my dividend cash each year.

But the rapid earnings growth of recent years is set to come to an end with a couple of flat years, though analysts are expecting the progressive dividend to keep growing. That would lift the yield to 6.1% by 2021, but would drop cover to 1.9 times — not a huge worry, but I don’t like to see things like dividend cover going in the wrong direction.

Still, saying all of that, I still think Lloyds is a buy at today’s valuation… providing we don’t crash out of the EU with no trade deal.

Deal or no-deal?

Will Boris go back on his word and agree an extension if 11 months isn’t long enough (which it really doesn’t seem to be)? We really do need a good trade deal to avoid an economic disaster, and that’s the thing I think could give Lloyds a boost.

I see much of the Brexit pessimism already built into the Lloyds share price, and I reckon that P/E of eight is way too low for a post-EU trade deal situation. Should we get a deal, I can see a P/E of 10 to 12 coming soon after, suggesting a share price of between 70p and 84p.

Dividend yields would be around 4-5%, which seems about right, long term, for a bank.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Alan Oscroft owns shares of Lloyds Banking Group. 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.

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