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Here’s why the Lloyds share price could climb when the PPI scandal is over

As a shareholder who thinks they’re cheap, I keep asking myself what it will take for Lloyds Banking Group (LSE: LLOY) shares to recover to what I see as fully valued. I can’t help wondering if one thing will be the final end of the PPI compensation saga.

That came a step closer on Wednesday as Lloyds announced that it has set aside a further £460m in the second quarter to provide for expected claims up until the deadline of August 2019. The extra amount takes the total earmarked for settling claims to over £19bn, which is a pretty staggering sum.

That’s based on a volume of claims of around 13,000 per week, up from previous assumptions of 11,000, as volumes have been rising lately. That’s probably not surprising, considering how many people tend to leave things until the last moment, and we’re into the final year for claims now. And if there’s a last-minute rush, the eventual sum could climb even higher — Lloyds has suggested that every 1,000 claims per week above the current 13,000 figure should cost an extra £150m.

Profits leap

But the overall news for Lloyds shareholders looks good to me, as first-half statutory pre-tax profit climbed by 23% year-on-year to £3,117m. Though the cash set aside for future PPI costs was boosted, the bank’s charge for the six months to June actually fell by almost 50%, to £550m, and stronger underlying profit also provided a boost.

Underlying profit after tax ticked up by 38% to £2,267m with an effective tax rate of 27%. The bank expects that to drop to around 25% by 2020, which seems like more reason for optimism.

At the bottom line, EPS perked up by 45% to 2.9p, and an interim dividend of 1.07p per share was announced. Lloyds said the latter is “in line with our policy to maintain a progressive and sustainable ordinary dividend,” and it supports my confidence that forecast yields of 5.4% for the full year and 5.8% in 2019 are realistic and sustainable.

One-off hits included £377m in restructuring costs, including £155m for severance deals. That’s another area where costs in the future should continue to reduce as the firm cements its position as a UK-focused retail bank with an increasing drive towards capturing a big chunk of the online banking market.

Still a buy?

So what are we looking at as a possible investment now? Well, a modest uptick in the share price on the day of the announcement still leaves Lloyds shares on a forward P/E of just 8.8. That assumes a predicted 64% rise in EPS for the full year, so there’s certainly a bit of risk there. But Lloyds itself clearly thinks its shares are cheap, as its share buyback programme is continuing strongly.

A big issue holding back Lloyds shares must surely be Brexit and any implied threat to the dividend once we’re out. Although Lloyds is not so euro-focused these days, a weakening UK economy could certainly hurt it, and I can see why investors might fear that uncertainty.

But at least we can clearly see the end of the PPI tunnel now. I’m still holding, and I might even top up.

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Alan Oscroft owns shares of Lloyds Banking 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.