Is There A 60% Upside For Lloyds Banking Group PLC In 2016?

The latest global turmoil has seen Chinese share trading halted for the second time in a week with worldwide markets falling too, coupled with oil hitting ever-lower prices and Middle East tensions escalating. That’s been hitting our FTSE 100 banks too, but I reckon it’s throwing up even better bargains.

After a steady recovery from the depths of the crisis, Lloyds Banking Group (LSE: LLOY) shares have been dipping again of late and have lost 20% since their May 2015 peak, trading at 69p as I write. That puts it on a forward P/E multiple based on 2016 forecasts of just 9.2, when the long-term FTSE average stands at around 14.

I said recently that there could be a substantial upside for Barclays in 2016 – the turmoil has now pushed Barclays shares down to a forward P/E of only 8.2. And I reckon the same is true of Lloyds, especially as Lloyds is expected to pay out a significantly higher dividend yield than Barclays, of 5.1% against 3.6%.


Although there’s probably some natural cyclical contribution to the current downturn, I think the fall is overdone. And if we assume a long-term P/E for Lloyds of close to the market average, we’d be looking at a potential price gain of around 50% needed for a recovery to those levels. But on top of that, the high and progressive dividends (the FTSE average is only a little over 3%) suggest a higher rating would be justified. And I don’t think 60% is in any way an unreasonable target. That would imply a price of around 110p.

How reliable is that dividend going to be? At the first-half stage this year, chief executive António Horta-Osório said: “Our aim is to have a dividend policy that is both progressive and sustainable.” He added: “We expect ordinary dividends to increase over the medium term with a dividend payout ratio of at least 50 per cent of sustainable earnings.” That would imply a yield of 5.6% for 2016 would be closer to the firm’s medium-term targets, so there’s still room for a small further rise even without future earnings growth. With growth, I could see an effective yield at today’s price of 6% to 7% in two or three years.

What stress?

In the most recent Bank of England stress tests, reported on 1 December, Lloyds “comfortably” exceeded the required thresholds. Lloyds’ reported CET1 ratio of 12.8% and leverage ratio of 4.9% dropped only to 9.5% and 3.9%, respectively, in a modelled world of 9.2% unemployment and falls of 20% and 30% in housing and commercial property prices, respectively. There’d be no cap-in-hand begging at the government’s door in such a scenario next time.

One downside of Lloyds though is the government’s ongoing sell-off of its stake, which has been satisfying much of the institutional demand for shares and helping to keep the price down. With a target of disposing of the remaining stake of less than 11% by mid-2016, the overhang effect should continue for some more months, though as long-term investors we might have a little while yet to buy-up shares while they’re cheap.

Long-term cash

My suggested price targets here are really just speculation, of course, and the short term isn’t what counts. Over the long term, I see Lloyds as a strong income stock, with attractive growth prospects thrown in – and yes, I really can see it as one of 2016’s FTSE 100 winners.

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Alan Oscroft owns shares in Lloyds Banking Group. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.