Lloyds (LSE: LLOY) is one of the UK’s most loved and hated stocks. On the one hand, the bank has made an outstanding recovery since the financial crisis and investors realise this. However, on the other hand, Lloyds is still a bank, and while it’s considered to be one of the UK’s safest banking institutions, the group’s fortunes are dependent on the UK economy.
Indeed, shares in Lloyds are highly sensitive to any warnings about the state of the UK economy. Concerns about the UK’s economic prospects since Brexit have sent shares in the bank lower by 24% since the end of June.
But despite these declines, there are three reasons why shares in the bank are worth buying at current levels.
Unfairly punished
It seems that shares in Lloyds have been unfairly punished by Brexit concerns. As yet, the bank hasn’t reported any significant Brexit impact on earnings. City analysts have pencilled-in an earnings decline of 14% for the year ending 31 December 2016, but even if this decline materialises, Lloyds’ shares still appear cheap.
Based on current earnings forecasts, shares in Lloyds are trading at a forward P/E 7.4, which is a severe discount to peers such as Barclays and HSBC. Specifically, at the time of writing shares in Barclays and HSBC are trading at forward P/Es of 16 and 13.2 respectively.
Further, Lloyds is better capitalised and more profitable than both of these banking giants. Lloyds is targeting a return on equity of 13.5% to 15% while HSBC and Barclays are looking for returns of less than 10%. The group generated 0.5 percentage points of Tier 1 capital in the first half leaving it with a total Tier 1 ratio of 13%. At the end of the first half, Barclays and HSBC reported Tier 1 capital ratios of 11.6% and 12.1% respectively.
Income champion
Before the financial crisis shares in Lloyds sported a dividend yield of 7% and the bank appears to be heading back in this direction.
After recent declines, the bank’s shares support a dividend yield of 4.1% and City analysts have pencilled-in a yield of 6.2% for 2017 as Lloyds increases its cash return to investors.
A play on housing
Lloyds is the UK’s largest mortgage lender, so if you’re looking for a play on the UK’s housing market, the bank could be the perfect bet.
The UK needs more than 250,000 new homes every year and no matter what happens to the country after Brexit, this demand won’t evaporate. Therefore, there will always be a demand for mortgage products and as the largest lender in the market, Lloyds will find its services in demand.
For shareholders, this is great news and makes Lloyds somewhat of a defensive play. Mortgages are usually in place for several decades giving Lloyds a guaranteed income stream for many years after the initial paperwork is signed.
