Lloyds’ share price is still dirt-cheap! Should I buy it for its dividends?

The Lloyds share price still looks mega attractive when we consider its P/E ratio and dividend yields. But could dividend payments be about to disappoint?

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The Lloyds Banking Group (LSE: LLOY) share price has remained pretty robust despite the growing stormclouds approaching the UK.

Some investors may be surprised at this. Like any bank its profitability is highly sensitive to broader economic conditions. And what’s more, Lloyds relies solely on British customers to drive its bottom line. Other FTSE 100 banks like HSBC and Barclays have foreign operations to support profits.

For others, the benefit of rising interest rates still make the bank a buy. Higher rates allow banks like Lloyds to enjoy bigger returns on their lending activities.

So should I buy Lloyds for its rock-bottom share price? And what dividends can I expect to receive from the stock?

Rate increases

The latest Bank of England (BoE) economic healthcheck gives a useful guide as to where Lloyds could be heading.

Firstly, on Thursday the BoE hiked its forecasts again for consumer inflation. It now expects it to peak at 13% this year, raising the prospect of further chunky interest rate hikes.

Policymakers just raised the benchmark rate to 1.75% from 1.25%. This was the sixth straight increase and the largest single hike for 27 years.

Encouragingly for Lloyds, analysts at Morgan Stanley believe there could be a flurry of similarly sized hikes in the months ahead to tame inflation. This would likely provide another significant boost to the margins banks gets from lending money.

Impairments rising

Yet on balance, I won’t buy as I think the BoE’s update provides more for Lloyds and its investors to worry about.

It expects the British economy to enter recession later this year and keep contracting until the end of 2023. This would be the longest downturn since the 2008 financial crisis.

This is grim reading for cyclical companies like Lloyds. And it’s possible that things may end up even worse than the central bank predicts. After all, it’s made a habit of upping its inflation forecasts and slashing its GDP estimates in 2022.

Lloyds has already set aside £377m to cover possible loan impairments. And I expect it to continue adding to its provisions in the short-to-medium term at the expense of profits.

What about Lloyds’ dividends?

Share Price45.1p
Price movement in 2022-8%
Market cap£31.4bn
Forward price-to-earnings (P/E) ratio6.6 times
Forward dividend yield5.6%
Dividend cover2.7 times

As I said earlier, I think Lloyds’ share price has held up relatively well given the threat of a long and painful economic downturn. But I feel it’s in danger of sliding as conditions on the ground really start to deteriorate.

But what does this mean for its dividends? Well, City analysts still believe the bank will lift dividends in both 2022 and 2023 (to 2.54p and 2.62p per share respectively).

And these projections are well covered by anticipated earnings. But while I think it’s is in good shape to meet this year’s estimate I’m not so sure about 2023.

Dividend cover falls to a still-robust 2.5 times for next year. However this is based on predictions of a modest year-on-year 3% earnings fall.

It’s my opinion that profits could fall much more than current forecasts suggest as bad loans stack up and revenues slump. And this could leave Lloyds’ progressive dividend policy in tatters.

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.

Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays, HSBC Holdings, and 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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