At first sight, Lloyds wouldn't seem a natural choice for its investment potential going into the new year. It had a torrid 2015, dogged by the continuing reverberations the PPI misselling scandal, probes by the regulator into rate rigging, and, of course, global market sluggishness. Its stock value has suffered the consequences, leaving 28% on the ground since touching its maximum in May last year, when one share was worth 89p, and slid down to today's minimum of 67.80p. See chart. However, moving into the new year, Lloyds has many factors going for it and now there is a real buzz surrounding the stock.
Chart from WSJ.com
First of all, the fundamentals are solid: Lloyds underlying profits had grown by £6.36bn in the first three quarters of 2015, which represented a 6% increase on the previous year. Analysts forecast that profits will fall this year by as much as 8%, but by the end of year the banking group should have recovered lost ground and be back in the black. The focus on retail and business banking, while not heralding spectacular profits, hints at a conservative, i.e. sustainable culture within the business, which will suit the income-seeking investor just fine. This impression is reinforced by having comfortably passed the Bank of England stress tests last year: the BoE set a threshold of core tier 1 assets of 11%, well below Lloyds’ 13.7% core 1 capital ratio. This is particularly important because, with a total capital ratio of 22%, Lloyds will have a lot of leeway into how to manage its profits than before.
The dividend paid out to the company equity holders has been a rolling 2.15% for some time, a dividend ratio which is covered 10.8 times by the corporation's declared profits. Investors have been happy to forego profit in recent years, preferring for business proceeds to be reinvested back in the business to fuel growth and shore up its finances; however, there is a consensus among analysts that this is going to change this year. Most forecasts agree on a dividend of 5% in 2016, with the more optimistic observers calling for a dividend of 6-7% over the next couple of years. Lloyds Group Chief Executive Antonio Horta-Osorio stated: "Our aim is to have a dividend policy that is both progressive and sustainable. […] We expect ordinary dividends to increase over the medium term with a dividend payout ratio of at least 50 per cent of sustainable earnings."
Another factor to watch out is the flotation of the remaining shares owned by the government, announced for spring of this year. The government still owes 9% of Lloyds equities, down from the 43% it bought when it stepped in in 2009 to save the bank from financial catastrophe. After completion of the sale, expected for early June 2016, the bank is going to be wholly privately owned for the first time in seven years. There are rumours the shares are going to be sold with heavy discounts, as much as 5%. Although most shares have already been snapped up, this would be a real treat for investors to get their hands on, as, besides the dividend incentive, eventually the stocks would appreciate considerably resulting in capital gains.
Investment strategists also believe that there is a strong political will in the treasury for the sale to be profitable and to go ahead unhindered: consequently there will be pressure on regulators to go easy on Lloyds in this delicate phase. The optimism about Lloyds comes amid a general revaluation of the banking sector which, in the eyes of analysts at least, has largely recovered from the days of the credit crunch. The regulator has acknowledged that UK banks have, or at least are working towards having, a sufficient capital ratio, indicating that equity raising is not going to be a worry any more and paving the way for higher dividends to be paid out to investors across the whole sector.