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Are Virgin Money Holdings (UK) PLC And Lloyds Banking Group PLC The Perfect Banking Combination?

While Lloyds (LSE: LLOY) (NYSE: LYG.US) is making excellent progress, its earnings forecasts are perhaps slightly less than many of its investors had been hoping for. Certainly, it is doing a great job of rationalising its business, strengthening its balance sheet, has recommenced dividends and the government is reducing its stake, but bottom line growth of negative 2% this year and just 1% next year is hardly appealing.

Growth Potential

That’s where combining Lloyds with Virgin Money (LSE: VM) could be a sound move. The latter is forecast to increase its net profit by a rather modest 3% this year, before seeing it rise by an anticipated 51% next year. As such, Virgin Money could provide upbeat growth prospects during a time when Lloyds is expected to see its bottom line stagnate.

Valuation

Of course, there is more to Virgin Money than just strong growth prospects. Certainly, it has a relatively high price to earnings (P/E) ratio of 18.3 but, when its earnings growth potential is taken into account, its price to earnings growth (PEG) ratio of just 0.2 indicates that its share price could move significantly higher. Likewise, Lloyds also offers excellent value for money, with considerable rerating potential over the medium term via a P/E ratio of 9.8, which shows that while the FTSE 100 has a P/E ratio of around 16, Lloyds could be on course for a significant share price rise.

Complementary Companies

Clearly, Virgin Money is relatively new to the banking world, while Lloyds has been around for a couple of centuries. Therefore, the two companies offer investors the perfect mix of new and old; of challenger and incumbent. And, while the banking sector remains very much skewed towards the size and scale of incumbents such as Lloyds, which have far greater loss-leading capabilities and the potential to cross-sell more effectively than the challenger banks, new entrants such as Virgin Money are also benefitting form a shift in consumer tastes towards a new and more transparent way of banking. As such, both banks appear to have bright futures.

Looking Ahead

In addition, both stocks seem set to benefit from a low interest rate environment, which should help Lloyds to continue the process of rebuilding its balance sheet, and also enable Virgin Money to tap into growing demand for new loans. Furthermore, the prospect of rapidly rising dividends at both banks should cause investor sentiment to improve over the medium term. For example, Virgin Money is expected to increase its dividends per share by 92% next year, while Lloyds is set to increase its shareholder payouts by 51% in 2016.

As such, and while they are two companies in very different stage of development, Lloyds and Virgin Money could make for an excellent combination, with their mix of growth potential, low valuations, increasing dividends and new versus old holding considerable appeal at the present time.

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Peter Stephens owns shares of Lloyds Banking Group. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.