Why Lloyds Banking Group PLC Is Set To Yield Over 6%

The saying ‘things take longer to happen than you think they will, but then they happen faster than you though they could’ perfectly sums up Lloyds (LSE: LLOY) (NYSE: LYG.US) as an income stock. After all, most investors are looking at Lloyds as something of a recovery, rather than income, play. That’s understandable, since Lloyds is still part-nationalised, has only recently returned to profit and only recommenced paying dividends last year after a handful of years without making any shareholder payouts.

However, that’s about to change. And, best of all, it looks likely to happen very quickly.

An Improving Outlook

Of course, the backdrop for Lloyds’s sudden thrust towards being an income stock is very favourable. First of all, a Conservative majority government was great news for the bank, since it ensures consistency with regard to the policy of selling off the government’s stake. Certainly, there may be a sale to the general public, but this will likely be the rump end of the government’s holding and, by this time next year, it is likely that the government will hold little (if any) stake in Lloyds. As such, investor sentiment should pick up.

Secondly, the UK economy is performing extremely well. Asset prices are on the up, monetary policy is very loose (and is set to remain so) and even the Eurozone economy looks as though it may end up surviving the global financial crisis. Certainly, there are potential challenges with a possible Greek exit, but then there is also the scope for improving economic performance resulting from QE, too.

Thirdly, Lloyds has been a step ahead of most of its UK-listed rivals in recent years. For example, it has adopted a ruthless attitude towards costs and has been able to drive down its cost:income ratio so that it is among the lowest in the listed banking sector in the UK. Furthermore, Lloyds has rationalised its balance sheet; divesting non-core assets so as to reduce its overall risk exposure to more prudent levels. And, when it comes to dividends, Lloyds also seems to be a step ahead of UK-listed peers, too.

Payout Ratio

In fact, Lloyds’ CEO announced that he was targeting a payout ratio of 65%. This means that, if Lloyds were to adopt this level of payout in the current year, it would equate to a dividend yield of 6.2%. That’s above almost every other FTSE 100 company when it comes to dividend yield, with a 65% payout ratio being highly sustainable, too.

Of course, Lloyds is not planning on paying out 65% of profit in the current year, with the figure being around 33%. However, it is expected to rise to 50% next year before increasing further over the medium term. So, even if profitability does not increase at a rapid rate, it seems likely that Lloyds will be yielding over 6% in the coming years.

Looking Ahead

Clearly, Lloyds is not without risk and the performance of the UK economy up to and following the EU referendum could cause investor sentiment in the bank’s shares to decline. Similarly, the continued sale of the government’s stake means that there will be numerous sales going through the dealing book, as the government drip-feeds the shares through.

However, for longer term investors, Lloyds remains a superb income stock. Not only is its strategy very sound, the UK is performing well and this should allow it to hit the 65% payout ratio it has planned, which should equate to a yield of over 6% over the next few years.

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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.