Lloyds (LSE:LLOY) shares have jumped 15% in 2023. But, for me at least, the stock still looks undervalued. In fact, there are several metrics to back this up.
So let’s take a closer look at why Lloyds, a typically boring and cyclical banking stock, remains my number one pick.
Three reasons Lloyds is cheap
Lloyds is a UK-focused bank with a considerable weighting towards the mortgage market. Some 70% of revenues come from UK mortgages. Naturally, these characteristics aren’t entirely attractive to investors right now.
Firstly, the UK is forecast to be the only G7 nation to experience a recession in 2023 — Britain’s GDP is expected to shrink 0.6% this year. That’s an unfortunate forecast. Banks are cyclical stocks meaning they do well when the economy is booming and poorly when the economy goes into reverse.
Typically, recessions and high inflation lead to more debt turning bad. In turn, this means banks spend more on impairment charges. Lloyds itself has already booked more than £1bn worth of loan defaults.
Secondly, and this is very much linked to point one, there is downward pressure on the housing market. Bank of England (BoE) data shows that mortgage approvals fell from 46,200 in November to just 35,600 in December.
Finally, investors have seen the UK as a low growth environment since the Brexit vote. The UK is very much unmoored and it’s not clear what the country’s direction is. Banks, which tend to reflect the performance of the economy, clearly suffer in such an environment.
So why am I buying?
Lloyds isn’t underperforming in this environment. In fact, amid a higher interest rate environment, revenue is soaring. Analysts at Barclays recently upgraded it to ‘overweight’ from ‘equal weight’, with a new price target of 75p, up from 55p.
“We see a more enduring tailwind from rising rates than previously and RoTE less impacted by excess liquidity/deposit outflows, alongside falling provision risks given UK macro de-risking“, analysts said.
It doesn’t have an investment arm and because of its funding composition, it has higher interest rate sensitivity than other banks. Net interest margins were pushing towards 3% at the end of 2023.
Moreover, Lloyds is even earning more interest on its deposits with the BoE. Evidence suggests that Lloyds may receive £200m in interest revenue for every 25 basis point hike.
Analysts at Barclays also highlighted Lloyds’s sector-leading qualities, suggesting the lender will return around 45% of its £36bn market-cap by 2025. They add that the bank trades at seven times estimated earnings, versus a European average of eight times.
Moreover, City experts are forecasting a full-year dividend of 2.4p in 2022, rising to 2.7p and 3p in 2023 and 2024 respectively.
So despite concerns about the impact of a recession on a cyclical stock like this, I believe the current conditions are fairly exceptional — in a very positive way.
As such, at 54p, I’m buying more Lloyds shares as I see it pushing up further and I’m excited by the dividend forecast.
