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Here’s why I’d buy Lloyds Banking Group plc after Q3 profits double

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This is how the future could look for shareholders of UK banks.

Lloyds Banking Group (LSE: LLOY) said this morning that its pre-tax profits rose by 141% during the third quarter, rising from £811m last year to £1,951m.

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The reason for this? Lloyds didn’t have to set any extra cash aside for PPI compensation claims during the quarter. Indeed, the bank still has £2.3bn of unspent provisions available for future claims.

It’s too soon to say whether this will be enough to see the bank through to the PPI claims deadline in August 2019. But what does seem clear from today’s figures is that the bank is performing well and can make a fair claim to be one of the FTSE 100’s top dividend stocks. It’s certainly a stock I’d consider adding to my own portfolio at current prices.

Strong underlying performance

Leaving PPI aside, Lloyds’ performance was still strong. Underlying profit for the first nine months of 2017 rose by 8% to £6.6bn. This lifted the group’s underlying return on tangible equity by 1.4% to 16.2%, which is far better than most of the bank’s main rivals.

The group’s profitability is continuing to improve. Net interest margin — a measure of the difference between interest charged and interest paid — has risen to 2.85% so far this year, up from 2.72% for the same period last year.

That’s better than most peers, and one reason for this is that Lloyds’ costs are much lower. The group’s underlying cost-to-income ratio fell by 1.8% to 45.9% during the first nine months of the year. The equivalent figure for Royal Bank of Scotland Group during the first half of this year was 53.1%.

The outlook for growth

The acquisition of MBNA’s credit card business earlier this year is starting to pay dividends — net interest income from MBNA totalled £186m during the third quarter. Concerns about rising levels of bad debt seem unfounded at the moment. The bank said that 1.7% of its total loan book was impaired at the end of September, down slightly from 1.8% at the same point last year.

The recent acquisition of Zurich Insurance’s workplace pensions and savings business will bolster Scottish Widows. This is expected to be one of the main areas targeted for growth by chief executive António Horta-Osório over the next few years, along with an increase in lending to small businesses.

Are the shares a buy?

Lloyds’ shares remain affordably priced, in my opinion. The bank has a tangible net asset value of 53.5p per share, putting the stock on a price/tangible book ratio of 1.25. This seems cheap to me for a profitable, well-capitalised bank with a forecast dividend yield of 5.9%.

In my view the only serious risk for shareholders is that Lloyds’ business is totally focused on the UK. So a recession at home would almost certainly hit the group’s earnings. However, in my view this is a risk worth taking. Its balance sheet is much stronger than it was in 2008/09.

With a well-supported forecast yield of almost 6%, I’d rate Lloyds as an income buy.

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Roland Head owns shares of Royal Bank of Scotland Group. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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