Are Lloyds Banking Group plc’s super dividends as good as they seem?

Lloyds Banking Group (LSE: LLOY) was hit hard by the EU referendum result, and at 57p today the shares are still down 21%. But one effect is that it makes an already attractive dividend yield look even better for potential investors — if the payments do actually happen as expected.

Lloyds resumed paying dividends in 2014 with a modest 1% yield, upped to 3.1% the following year. Forecasts of 3.2p and 3.8p per share pencilled-in for 2016 and 2017 would provide shareholders with yields of 5.6% and 6% respectively, and those are up among the biggest dividends in the FTSE 100.

Falling forecasts

The major caution is that Lloyds might not be able to meet those expectations. Indeed, analysts have cut back on their forecasts in recent months — three months ago the consensus suggested 4.4p per share this year followed by 5.1p next, for yields of 7.7% and 8.9% at today’s share price.

We also have declining earnings forecasts, with a fall in EPS of 14% this year followed by a further 13% next year. And with loans to small and medium sized businesses dropping 10% in the second quarter of this year (according to the British Banking Association), are we starting to see a dim picture for Lloyds’ prospects?

The bank is perhaps not as attractive as it was a few short months ago, but I reckon the gloom and despondency have been overdone. There’s still a pretty strong buy rating being put out by the City’s tipsters, and I see the longer-term potential for Lloyds as being firmly in line with that.

Strong balance sheet

For one thing, even with lowered forecasts, we’re still seeing those potential payouts covered 2.3 times and 1.9 times respectively by earnings, and that seems more than adequate for a bank with such a strong balance sheet. Lloyds scored highly in the most recent EU-wide stress tests in August, with resulting ratios even in the tests’ adverse scenario looking comfortable. Lloyds said of it: “This outcome reflects the de-risking undertaken and reaffirms the strong capital and balance sheet position of the group.

And at the halfway stage this year, the bank lifted its interim dividend by 13% “in line with our progressive and sustainable approach to ordinary dividends.” There was a note of caution sounded in the light of post-Brexit uncertainty, but Lloyds won’t want to rein-in its new dividend policy unless it really has to.

On a P/E basis, Lloyds is looking cheap in comparison to its peers too — forward multiples of 7.8 this year and 8.9 next are way below the FTSE 100’s long-term average of around 14, and are significantly below the 10-15 P/E levels seen at Barclays and 17 at Royal Bank of Scotland.

Uncertainty? Pah!

We’re in for a fair bit more uncertainty following the Brexit vote for sure — article 50 of the Lisbon treaty has yet to be invoked and once it is, it will be at least another two years before the process of leaving is concluded. And that uncertainty seems likely to keep Lloyds’ share price depressed in the short-to-medium term.

But I still see a bank that’s in good shape compared to its peers, and one that has a very strong long-term future. I fully expect Lloyds’ shares to be valued significantly higher in five years time.

And in the meantime, keep taking the dividends.

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Alan Oscroft owns shares of 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.