Lloyds (LSE:LLOY) shares have faced significant downward pressure, not just this year, but over the last decade. The UK’s largest mortgage lender is not an investor favourite, despite several reasons for optimism. So with Lloyds shares currently trading around 44.5p, here’s my reasons for buying.
Challenges
Of course, any investment thesis must recognise the associated drawbacks. With Lloyds, there’s a few. And these have contributed to the depressed nature of the bank‘s shares in recent years.
- An uncertain global economic outlook: The war in Ukraine, rising inflation, and the possibility of a global recession are all weighing on investor sentiment. Bank stocks are cyclical, and this contributes to the broad negativity around the sector.
- Less exposure to growth: The UK is not billed to be one of the fastest-growing parts of the world in the coming years. Far from it. Moreover, the UK economy faces more challenges than other parts of the developed world.
- Investors remember: Lloyds was bailed out by the government during the financial crisis of 2008. This still impacts investor sentiment to this day.
- Things might turn bad: Stubborn inflation, rising interest rates, and a possible recession could all lead to more defaults on loans made by the bank. In turn, Lloyds may face higher impairment charges in the near term.
Looking beyond
The above concerns don’t prevent Lloyds from being a well-run, cash-generating business. In fact, it’s been particularly cash generative over the past 12 months. With interest rates rising, Lloyds has experienced a tailwind unseen in my lifetime.
Mortgages make up around 65% of Lloyds’s loans, and 95% of the bank’s assets are based in the UK. Coupled with the absence of an investment arm, Lloyds is one of the most interest rate sensitive banks in the country.
While the net interest margin has surged in the current environment, Lloyds is also earning more interest on the money it leaves with the Bank of England (BoE). Analysis from late 2022 suggested that each 25 basis point hike by the BoE base rate would add close to £200m in treasury income alone.
To date, evidence strongly suggests that the windfall from higher net interest margins will greatly surpass the cost of higher default levels. My thoughts were reinforced by the BoE’s conclusions last week. “The UK economy and financial system has so far been resilient to interest rate risk,” said BoE govenor Andrew Bailey.
Taking full advantage
Last week, all British banks passed the central bank stress test. This is particularly important for Lloyds as it’s less diversified business made it potentially more exposed to pressure resulting from higher interest rates. The Lloyds share price reacted to this, alongside lower than expected US inflation, by pushing upwards. The events furthered my conviction in Lloyds.
Investing in Lloyds offers a compelling opportunity with its robustness, low P/E ratio (5.94 times), and exceptionally well-covered 5.4% dividend yield. The projected dividend increase from 2.4p in 2022 to 2.7p in 2023, and further to 3p in 2024, enhances its appeal.
A strong investment case emerges, combining potential capital appreciation, reliable income, and sustained growth prospects.
