It pays to be conservative when managing the expectations of a tetchy market. For Lloyds Banking Group, though, that meant investors looked past an upgrade to its margins and returns guidance this year, which were already firmly embedded in consensus figures.
It’s hardly surprising that with inflation still well above the Bank of England’s target of 2 per cent, Threadneedle Street would go further on ratcheting up rates, in turn keeping Lloyds’ margin fatter for longer. The lender expects its net interest margin, a key gauge of profitability that reflects the difference between what a bank charges for loans and pays out on deposits, to be above 3.10 per cent this year, better than the 3.05 per cent it had stuck to three months ago. The return on tangible equity is now expected to be more than 14 per cent, against the 14.3 per cent already baked into analysts’ forecasts.
After tinkering with its economic assumptions, Lloyds now expects the Bank’s base rate to peak at 5.5 per cent in the third quarter of this year, from the lowball 4.25 per cent it had pencilled in. It also thinks the UK will narrowly avoid a recession.
Naturally, the consequences of higher rates aren’t all positive. Another £419 million in impairments was taken in the second quarter, £84 million of which was as a direct result of the changes to assumptions. That was worse than the £317 million analysts had expected.
Investors’ eyes were fixed more closely on the impact on affordability for borrowers. About 35 per cent of mortgages are maturing this year, with the average payment for those coming off fixed rates in the first half rising by about £180 and set to increase by £360 a month during the second half of the year, according to Charlie Nunn, Lloyds’ chief executive. Not surprisingly, mortgage lending volumes were also more subdued.
A keener eye on bad potential defaults is not surprising, particularly given that the sugar rush of higher interest rates won’t last. The net interest margin has already started to deflate, having peaked at the start of this year. Competition within the mortgage market remains tough.
During the second quarter, the margin made from new mortgage business declined to 50 basis points, less than a third of the 180 basis points generated on those written in 2020 and 2021 and now maturing.
Meanwhile, gradually passing on more of the benefit of higher rates to customers should increase the cost of this source of funding. In the second quarter, the net interest margin declined to 3.14 per cent, from 3.22 per cent three months earlier.
The shares trade at a near-20 per cent discount to the forecast tangible book value at the end of this year, against a premium afforded to the stock at the start of this year and before the pandemic hit. It is befitting of the extreme wider economic conditions pervading over the past three years.
The dividend, at least, is something investors should be able to rely on. The lender is well over halfway to achieving a full-year capital generation target of 1.75 per cent, equivalent to £3.5 billion, notching up 1.11 per cent over the first six months of the year.
There’s also roughly £1.4 billion in excess capital held by the bank, which the company intends to reduce by the end of next year. Split the latter in two and that leaves £4.2 billion in capital, easily enough to fund an increase in the £3.6 billion dividend payout last year. Revenue targets for an additional £700 million by next year, and £1.5 billion by 2026, from chasing wealth management custom from the “mass affluent” remain on track, according to Nunn. But as the rate benefit fades, there will be more onus on Lloyds’ side-bets to start proving their worth.
ADVICE Hold
WHY The shares offer a generous dividend yield but could face further volatility
Reckitt Benckiser
Reckitt’s incoming boss Kris Licht will need to be ruthless if the company is to break free of its pedestrian growth after a period of punchy price rises. A decline in second-quarter sales volumes announced yesterday was more severe than had been expected in the City, down by 4.3 per cent against a consensus forecast of 3.6 per cent, even if lifting prices meant that like-for-like sales growth overall was better than expected at 4.1 per cent.
The shares are flat compared with where they were eight years ago and a forward price/earnings ratio of about 16 trails domestic and international peers and is close to a ten-year low.
Inflation aside, extracting where genuine demand lies has been complicated by extraordinary conditions in some key markets. In nutrition in the United States, Reckitt is lapping a baby formula supply slump from Abbott, its chief competitor, although it has managed to hold on to some of the market share gained through the shortfall. Volumes for that business were almost 7 per cent lower in the second quarter, double the step-down in the first three months of the year. Sales of Lysol and Dettol, the disinfectant brands, also have had to contend with tough pandemic-era comparisons.
Reckitt reckons that increasing sales of more profitable health brands, such as Lemsip and Nurofen, ahead of hygiene products, including Harpic or Dettol, can push its adjusted margins ahead of revenue growth in the medium term. It has stuck with a target of an operating margin in the mid-twenties by the mid-2020s, which would put it near the top of its peer group. Over the first half of the year that stood at 23. Yet that could prove unrealistic if the new boss decides Reckitt needs to take a more aggressive approach to pushing the top line faster. Marketing spending has risen to 12.3 per cent, from 11.7 per cent over the same period last year, but that is still far behind Haleon and a whisker behind Unilever, a company that also looks in need of spending more to push its brands. That contributed towards a decline in the adjusted operating margin to 23.8 per cent, from 25.6 per cent year-over-year.
ADVICE Hold
WHY The incoming boss could deliver a revitalised strategy for top-line growth
