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Lloyds Banking Group PLC vs Royal Bank Of Scotland Group plc: Which Part-Nationalised Bank Will Win?

The period of time when it looked as though the likes of Lloyds (LSE: LLOY) (NYSE: LYG.US) and RBS (LSE: RBS) (NYSE: RBS.US) might not make it as viable businesses seems like a long time ago. Of course, the legacy of the credit crunch is still very much with us, since both Lloyds and RBS remain part-owned by the taxpayer. And, while Lloyds has easily outperformed its sector peer thus far in 2015, with it being up 14% versus a fall of 10% for RBS, is it a better buy? Or, will RBS turn the tables and outperform Lloyds moving forward?

Share Sales

Now that the Conservatives have an outright majority in the House of Commons, the futures of the two banks appear to be rather more certain than they were a couple of months ago. That’s because their path to full public ownership (i.e. with no government stake) appears to be relatively clear and, although there are no plans in place, it seems likely that both banks will no longer count the government as a shareholder by the end of the current parliament in 2020.

This should be hugely beneficial for RBS, rather than Lloyds, since the former has not experienced particularly strong investor sentiment in recent years. Meanwhile, Lloyds has benefitted hugely from the sale of the government’s stake, since it provides investors with the confidence that the bank is moving in the right direction and is healthy enough to wean itself off state aid. As such, the improvement in investor sentiment that has pushed Lloyds’ shares higher by 233% in the last three years could be focused on RBS over the medium term.

Valuation

As a result of its superb share price performance, it is not surprising that Lloyds offers less value for money than RBS. However, the size of the difference between the two banks is very, very large and, while Lloyds is not exactly expensive, RBS is dirt cheap at the present time.

For example, RBS has a price to book (P/B) ratio of just 0.68. That’s astonishingly low, given the fact that it is now profitable, the UK economy is growing at a rapid rate, and the global financial crisis is well and truly behind us. In fact, Lloyds also has a low P/B ratio of 1.25 and, as such, its share price could move significantly higher. However, RBS is by far the cheaper and, were it to trade on the same P/B ratio as Lloyds (which is not particularly high), its shares would be priced at 641p, which is 82% higher than their current level.

Income Prospects

Of course, where Lloyds is streets ahead of RBS is with regard to income prospects. For example, next year it is expected to pay out 4.2p in dividends per share and, at its current share price, this equates to a dividend yield of 4.9%. As such, Lloyds is set to become a very appealing income stock within the next six months or so and, on this front, RBS simply cannot compete – yet.

That’s because, in 2016, RBS is expected to yield just 1.5%; well below Lloyds’ 4.9%. However, RBS is set to have an ultra-low payout ratio of only 21%, versus Lloyds’ still modest payout ratio of 51%. Were RBS to pay out 51% of its profit next year, it would equate to a yield of 3.7% and, while this is still lower than Lloyds’ forward yield, it shows that, in time, RBS could also become an appealing income play, which reduces Lloyds’ advantage over RBS when it comes to income potential.

Looking Ahead

As a shareholder of both banks, I’m bullish on their long term prospects and feel that they both offer excellent capital gain and income potential. However, RBS is cheaper than Lloyds by some degree, and could be set to benefit from an upturn in investor sentiment as the government’s stake is sold off. And, while Lloyds is a better income stock in the short term, the difference between the two in this regard should narrow over the next handful of years. Therefore, while both are strong buys, RBS edges this battle and could be set to soar.

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Peter Stephens owns shares of Lloyds Banking Group and Royal Bank of Scotland 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.