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

How high can Lloyds Banking Group PLC (LON: LLOY) shares climb in 2016?

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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%.

Oversold?

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.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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.

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