Share investing is a classic play on current and future risk versus potential rewards. At what point does FTSE 100 bank Lloyds Banking Group (LSE: LLOY) finally become cheap enough to warrant a punt?
The Black Horse Bank lost its pull as go-to share for dividend investors this month. Adhering to the Prudential Regulatory Authority it axed the final payout for 2019, and vowed to scrap paying dividends this year or engage in share buybacks.
Still, Lloyds may still hold some appeal for value investors. Its forward price-to-earnings (P/E) ratio of 9 times still makes it one of the cheapest stocks on the Footsie.
Does this represent a brilliant dip-buying opportunity? Or is it a trap waiting to trip up glass-half-full investors? I can’t help but feel it’s a case of the latter. I certainly won’t be buying the FTSE 100 share given the prospect of a sharp and stretched out economic recession.
The Office for Budget Responsibility (OBR) suggests that the UK economy will shrink by 35% in 2020 because of the Covid-19 crisis. Naturally, this scenario would cause havoc for all of Lloyds’ operations as both individuals and corporate customers struggle. Here I will talk about the possible consequences for the company’s mortgage business.
Lloyds is by far the country’s biggest mortgage lender with a market share north of 20%. Last year two-thirds of all loans and advances to its customers were in the form of mortgages. It stands to reason that it faces significant trouble as the UK housing market stalls.
It’s not just the immediate impact that government advice to close down home sales is having. Lloyds faces a tough time even when Covid-19 infection rates slow and quarantine measures are gradually lifted. In the subsequent recession unemployment rates are expected to spiral out of control. The OBR says that jobless numbers could soar by an extra 2m as the UK economy tanks.
Illustrating the possible impact on major lenders like Lloyds, estate agency Knight Frank estimates that banks and building societies could issue 350,000 fewer mortgages for house purchase in 2020 than they otherwise would have done.
It’s not just in the income column where Lloyds threatens to take a hit, however. It also faces an escalation in the number of bad loans on its books as Britons likely struggle to make ends meet in larger numbers.
I’d steer clear of Lloyds
The picture is bleak for Lloyds and getting more so. It’s why City analysts have been downgrading their earnings forecasts for 2020. They now expect Lloyds to endure a 9% drop in annual profits but investors should be braced for more cuts to estimates as the coronavirus crisis drags on.
The bank’s share price has dropped 62% over the past five years. It’s unlikely to rebound any time soon as weak economic conditions prolong an environment of profits-crushing low interest rates. This is a share I’d avoid at all costs, despite that low price.
Royston Wild has no position in any of the shares mentioned. 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.