The Lloyds Banking Group (LSE: LLOY) share price is down by about 15% from its mid-summer high of 67p. With the economic outlook more uncertain than ever, it’s hard to know whether you should be buying or selling this UK-focused stock.
In this article I’ll explain what I think is happening and highlight a revealing trend. I’ll finish up by giving my verdict on the outlook for this popular dividend stock.
Forecasts show 2020 slowdown
As part of my job as a stock market writer, I look at a lot of earnings forecasts for different companies. Recently, I’ve started to notice a trend. Analysts have been cutting their growth forecasts for 2019.
Lloyds is a good example of this. A year ago, consensus forecasts suggested that the bank’s earnings would rise by about 3% in 2020. Those same forecasts now expect Lloyds’ earnings to fall by about 3% next year.
I don’t take these City forecasts as gospel. But analysts tend to follow economic data quite closely and have good access to big companies. I think it’s fair to assume that based on the latest data, there’s a good chance the UK economy might slow next year.
If this is correct, banks like Lloyds could suffer slower lending growth and rising bad debts, pushing down profits.
A difficult three months
Lloyds released its third-quarter results on Thursday. The numbers painted a mixed picture. On the one hand, lending growth continued. Total loans rose by 1% to £447.2bn, mostly thanks to a £6.1bn increase in mortgage lending, which rose to £271m.
Profit margins on this lending also held up well. The bank’s net interest income rose by 2.2% during the quarter. Lloyds’ net interest margin was almost unchanged, at 2.9%. This measure of profitability looks at the difference between the interest charged on loans and the interest paid on deposits.
Despite this, the bank’s underlying return on tangible equity fell from 15.6% in Q2 to 14.3%. And while that’s still a respectable figure, it doesn’t include the impact of the bank’s provision for an extra £1.8bn of PPI claims. This wiped out the bank’s profits for the three-month period, resulting in a £238m after-tax loss.
I’m more worried about this
Personally, I wouldn’t get too hung up on the cost of PPI. The claims deadline has now passed. In my view, this costly scandal is now history.
I’m much more worried about the rising trend of bad debt charges reported by Lloyds this year.
Over the last 12 months, the bank’s quarterly impairment charge has risen from £197m to £371m – an increase of 88%. If this trend continues, then I think we could see bad debts start to put real pressure on profits in 2020.
My verdict
I think that there’s a growing risk of a UK economic slowdown in 2020. But I don’t think Lloyds shareholders need to worry about a repeat of the 2008 crash. The bank’s balance sheet is much stronger now than it was then.
Current forecasts show next year’s dividend being covered twice by earnings. I suspect that the dividend will be sustainable even if earnings do fall next year. At current levels, the shares offer a yield of 5.8%, rising to 6.2% in 2020. I’d view this as a buy. And if the stock does drop below 50p next year, I’d be inclined to buy more.
